The banking and financial sector plays a crucial role in the economic development of a country. However, the sector faces various challenges, one of which is the issue of Non-Performing Assets (NPAs). NPAs have become a significant concern for Indian banks and lending institutions, affecting their profitability, liquidity, and overall financial stability. Understanding what are non-performing assets, their types, and their impact on lenders and borrowers is essential for maintaining a healthy financial system.
What are Non-Performing Assets?
Non-performing assets (NPAs) refer to loans or advances made by banks or financial institutions that have not been repaid or have become overdue for a specified period. In other words, when a borrower fails to make interest or principal payments on a loan for an extended period, the loan is classified as a non-performing asset. These assets are considered non-productive as they do not generate any revenue for the bank or financial institution.
How Do NPAs Work?
Lenders don’t label loans as NPAs right away; they wait for a period of non-payment, typically 90 days. During this time, they assess various factors that may cause payment delays and may grant a grace period. However, if payments remain overdue for 90 days, the loan is classified as an NPA (non-performing asset).
Suppose a borrower continuously fails to make payments over an extended period. In that case, the lender may demand the sale of any assets or collateral pledged against the loan to recover the debt. In cases where no assets were pledged, the lender might write off the loan as a loss and sell it to a bad bank. These specialised institutions handle bad loans, aiming to relieve the original lenders of the burden.
Types of Non-Performing Assets
Non-performing assets can be categorised into the following types:
1. Substandard assets –
Substandard assets are those with repayment of principal and/or repayment interest overdue for more than 90 days but not exceeding 12 months. These assets pose a higher risk of default and require special attention from the bank to prevent further deterioration.
2. Doubtful assets –
Doubtful assets are those with arrears exceeding 12 months. There is a significant risk associated with recovering these assets, and banks often need to make provisions to cover potential losses. These assets require intensive monitoring and may require substantial restructuring to recover.
3. Loss assets –
Loss assets are those where the losses have been identified by the bank, internal or external auditors, or the Reserve Bank of India (RBI), but the amount has not been written off wholly. These assets are considered irrecoverable, and banks must write off the outstanding amount from their books to accurately reflect their true financial position.
NPA Provisioning
Provisioning refers to the amount financial institutions keep aside from their income or profits during a specific quarter for non-performing assets. It is a financial risk management technique used by financial institutions through which they can account for their NPAs and other assets that may become losses in the future.
The provisioning regulations and norms for financial institutions across the country are determined by the Reserve Bank of India (RBI). These regulations vary based on the type and size of the NPA, as well as the lender’s location.
GNPA and NNPA
1. GNPA
- Stands for “Gross Non-Performing Assets”
- Refers to the total non-performing loans classified by the financial institution
- Are indicators of the overall asset quality and health of a financial institution
- Directly impact the provisioning requirements and capital adequacy of financial institutions
2. NNPA
- Stands for “Net Non-Performing Assets”
- Refer to the amount left after subtracting loan loss provisions from the GNPA
- Are better indicators of a financial institution’s credit risk exposure
- A lower NNPA suggests the financial institution manages its loan issues via provisions
NPA Ratios
NPA ratios provide financial institutions with insights into their financial health and the quality of their assets. The most commonly used NPA ratios are the GNPA ratio and NNPA ratio.
The GNPA ratio refers to the total proportion of total loans a lender has that have become their NPAs. On the other hand, net NPA ratios are used to determine the ratio of net NPAs to the total advances of a financial institution.
Both the GNPA ratio and the NNPA ratio are useful tools that allow financial institutions to asses which advances are recoverable, and which are not.
What are Non-Performance Assets Examples?
1. Corporate loans
When businesses fail to repay their loans due to factors like economic downturns or mismanagement, their loans become NPAs. For instance, if a manufacturing company defaults on its loan payments due to a decline in demand, the loan becomes an NPA.
2. Agricultural loans
Loans extended to farmers can turn into NPAs if borrowers fail to repay them, often due to crop failure or natural disasters. This is a significant issue in India, where agriculture is crucial to the economy.
3. Retail loans
Personal, home, and vehicle loans can also become NPAs if borrowers default. Common reasons include job loss or medical emergencies. For example, if an individual fails to repay their home loan due to unemployment, it becomes an NPA.
Calculation of NPA
Banks use various ratios to measure and monitor the level of NPAs. The most commonly used ratio is the Gross NPA ratio, which is calculated as follows:
Gross NPA Ratio = (Total NPAs / Total Loans and Advances) × 100
Gross NPAs refer to the total outstanding principal amount of non-performing assets, while Gross Advances represent the total outstanding loans and the bank makes the bank.
Now that we understand what are non-performing assets, the question arises: What are the non-performing assets of the company?
Factors that can lead to NPA
Several factors contribute to the formation of non-performing assets:
– During periods of economic downturn, businesses may face financial difficulties, leading to loan defaults.
– If borrowers divert funds for purposes other than those specified in the loan agreement, it can lead to loan defaults.
– Poor management practices, lack of planning, and inefficient resource utilisation can lead to business failures and, consequently, loan defaults.
– Natural disasters, like earthquakes, droughts, or floods, can adversely impact borrowers’ ability to repay their loans.
– Changes in government policies, such as taxation, interest rates, or regulations, can impact borrowers’ financial performance and their ability to repay loans.
What is the impact of NPAs?
Non-performing assets can have significant consequences across various sectors:
– On the Indian economy
High NPAs strain banks’ financial health, limiting their ability to lend and hampering economic growth by reducing credit flow to businesses.
– On creditors
NPAs cause banks financial losses and reduced profitability, erode investor confidence, and hinder their capacity to raise capital from the market.
– On debtors
Borrowers face higher borrowing costs as banks raise interest rates to offset NPA losses. This limits funding opportunities for viable projects, hampering economic development and job creation.
To end
Non-performing assets (NPAs) are a significant concern for the banking and financial sector in India. They affect the profitability and stability of lending institutions and have far-reaching consequences for borrowers and the overall economy. Addressing the issue of NPAs requires a concerted effort from both lenders and borrowers.
Banks and financial institutions must strengthen their risk management practices, conduct thorough credit assessments, and implement effective recovery mechanisms. Borrowers, on the other hand, should prioritise timely loan repayment to maintain a good credit history and avoid legal consequences.
At Tata Capital, we offer personal loans with flexible tenure of up to 6 years and customised loan amounts ranging from Rs. 75,000 to Rs. 35 lakhs. This allows you to select a tenure and loan amount you can repay comfortably without straining your budget. Moreover, our small personal loans feature a hassle-free online application process and competitive personal loan interest rates.
FAQs
Financial institutions typically attempt to recover loans categorised as NPAs. However, if they cannot, the amount is written off as a loss, and they must keep provisions aside to cover them.
Lenders have many ways to deal with NPAs, like trying to recover the amount, selling the NPA to an asset reconstruction company, or restructuring the NPA.
If your account becomes NPA, the financial institution is required to report it to credit information companies. This could negatively impact your credit score.
Formal notices are sent out after 60 days of non-payment. Lenders will increase recollection efforts if it exceeds 90 days, and legal action can be taken. Interests and penalties may also arise.
Borrowers must contact their lenders and express their willingness to settle a debt. They must also provide information about their financial situation and negotiate a settlement amount.
NPAs are classified depending on their repayment status. If loans are overdue for more than 90 days, financial institutions will classify them as NPAs.
18 February 2025
7 mins read
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