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 do you mean by 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.
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?
What are the non-performing asset types?
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.
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.
Visit the Tata Capital website or download the Tata Capital App today!
28 May 2024
6 mins read
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