What is a Non Performing Assets?
Non Performing Asset (NPA) refers to the classification used by financial institutions for loans and advances that are in default or in arrears. A loan is in arrears when the principal is due, or interest payments are late or missed. While a loan is in default when the loan agreement breaks, or the borrower is unable to meet its obligations.
RBI has specified the time period that classifies the loans and advances under NPAs. As per the classification, NPA is any advance or loan that is overdue for 90 days or more. Therefore, an asset becomes non-performing when it ceases to generate income for the bank or lender because the borrower is not paying interest. These loans and advances can be a term loan, overdraft/cash credit, discounted bills, etc.
Categories of NPAs
The RBI has categorized NPAs into three broad categories depending on the period of default. The following are the subcategories of NPAs –
- Sub-Standard Asset: Any loan or advance is a sub-standard asset if it remains outstanding or NPA for a period less than or equal to 12 months.
- Doubtful Asset: Any loan or advance is a doubtful asset if it remains outstanding or NPA for a period of more than 12 months and is already classified as a sub-standard asset.
- Loss Asset: Any loan or advance is a loss asset if it remains “uncollectible” or has little to no recovery value, as its continuance as a bankable asset is unsuggestible. Therefore, the bank may consider some recovery value left in it as the asset has not been written off wholly or in parts.
Provisions for Non-Performing Assets
Provision for Non Performing Assets means the banks keep aside a certain amount from their profits in a particular quarter for NPAs. This is because this asset can turn into losses in the future. Thus, by this method, banks can maintain a healthy book of accounts by provisioning for bad assets. Moreover, banks make provisions based on the NPA category, as mentioned above. Also, the provisions depend on the type of bank. For instance, Tier-I and Tier-II banks have different provisioning norms.
One can understand the NPA provisions by looking at the bank’s auditor’s report. As per RBI, banks have to make their NPA numbers public from time to time. There are two metrics that help to understand the NPA situation of the bank.
- Gross Non Performing Asset (GNPA): Gross Non Performing Asset is the absolute amount that shows the total value of loans for a bank that are due within the 90 days period in a particular quarter or financial year.
- Net Non Performing Asset (NNPA): Net Non Performing Asset shows the exact value of NPAs after the bank makes specific provisions for it. It is arrived at by subtracting the doubtful and unpaid assets from the gross NPA.
How Do NPAs Work?
The lender does not switch the loans or advances into the NPA category unless a specific period of non-payment has gone. Also, banks or lenders consider all the factors that may make the borrower delay in making interest and principal payments. Sometimes, they also give the borrower a grace period for payments. Banks typically consider it a loan overdue even after the grace period. However, banks still wait for a period of 90 days of non-payments and then consider the loan as a non performing asset.
After a prolonged period of non-payment, the bank will force the borrower to liquidate any assets or mortgage as a part of the loan agreement. If the borrower does not pledge any assets, then the bank may write off the loan as bad debt and sell it to the bad bank. The bad banks aim to ease the burden on banks by taking the bad loans off their balance sheet and lending them to customers again without constraints.
For instance, if someone takes out a second mortgage and that loan becomes an NPA. The bank will send a notice for foreclosure on the home because it is being used as collateral for the loan.
Significance of Non-Performing Assets
It is important that the borrower and lender must be aware of the performing and non performing assets. For the borrower, if the asset is non performing and does not pay the interest, it can have a negative impact on their creditworthiness and growth. Also, it will hamper their ability to obtain a loan in future.
Similarly, for bank or lender, the interest they earn on loans is a main source of income. Thus, a non performing asset will negatively affect their ability to generate income and thus impact their overall profitability. Also, it is important that the banks keep constant track of their non performing assets. This is because too many NPAs can adversely affect their liquidity or growth abilities.
A non performing asset can be manageable; however, it depends on how many they are and their past due period. In the short term, banks can tolerate a good amount of NPAs. But if the volume of NPAs increases over a period of time, it can threaten the financial health and future success of the bank or lender. This is why banks keep NPAs in their books, hoping to recover the money or make provisions for it. If they are unable to recover, they write it off entirely as bad debt.
Frequently Asked Questions
Gross NPA shows the total of all loan assets that haven’t been repaid by the borrowers within the 90-day period. Net NPA shows the amount remaining after deducting the doubtful and unpaid debts from the Gross NPA.
After a prolonged period of non-payment, the bank will force the borrower to liquidate the assets that were pledged as a part of the debt agreement. If no assets were pledged, then the lender will write off the asset as a bad debt. Also, it will have a negative impact on the borrower’s creditworthiness and growth. Furthermore, they will not be able to obtain a loan in future.
NPA figures are not available in the balance sheet as they are not a part of the financial statements published by banks. These figures are a part of the Auditor’s report where the Auditor discloses the NPA position in the Annexure of the Matter Paragraph or Other Matter Paragraph when indicating the position of the Assets (Advance/Credit Section of Bank). Basically, these figures are seen in the notes of the accounts.
Any loan or advance whose interest or principal payments are due, late, or missed is considered as non performing asset. Some of the NPAs are overdraft/ cash and credit accounts, agricultural advances, term loans, etc.
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