What is a nonperforming asset (NPA)
Reserve Bank of India defines NPA as any advance, loan, or payment that is past due for 90 days or more. The loan becomes an NPA if the borrower does not repay the loan and interest according to the schedule for more than 90 calendar days. NPAs can be classified according to how long they’ve been nonperforming.
Assets of a Bank and its Nonperforming Assets
In banking, loans are a good example of an asset. Financial institutions consider loan assets because of the income they receive from interest payments.
When clients, whether they are retail or corporate, have difficulty meeting their interest obligations, the asset becomes a “nonperforming” one. In these cases, the bank no longer derives income from these assets and marks them as nonperforming assets.
How do nonperforming assets (NPAs) work?
The bank’s ability to lend and its income will decrease when the NPA ratio in the loan portfolio increases. Loan defaults and write-offs are on the rise. The Reserve Bank of India and the Indian government have taken steps to reduce nonperforming assets in the banking industry.
Types and NPAs
According to the RBI’s directives for banks, NPAs can be categorized into four broad categories depending on their repayment status. These are:
1. Standard Assets: Standard assets are loans in which the borrower repays the principal and the interest on time.
Substandard Assets – These assets are those where the borrower defaulted on a loan for 90 days or longer.
Uncertain assets – This is a loan where the borrower defaulted on repayment for at least 12 months.
Loss assets – This is a list of loans that the bank has written off as they are uncollectible.
A provision is the amount of money that banks set aside in a quarter from their profit or income for nonperforming assets, like assets that could turn into losses. Banks use provisioning to cover bad assets and compensate for losses. The provisioning process is based on the category of an investment. In the previous section, we have listed all of the classes. The provisioning depends not only on the bank type but also on the asset type. Tier-1 banks and Tier-II have different norms for provisioning.
Banks can’t hide their NPA number. The numbers must be made public, and the RBI should see them frequently. Two metrics help us to understand the NPA status of a bank. The NPA figures for a particular bank are specified in its standalone financial statements.
- GNPA GNPA is now gross nonperforming assets. This gives you a total of the gross nonperforming assets in the bank for a specific quarter or financial period.
- NNPA: NNPA is expanded to net nonperforming assets. NNPA subtracts the provisions from the gross NPA to give you the value of the nonperforming asset.
The percentage of NPAs is also a way to express the amount. This gives us a good idea of what percentage of total advances can’t be recovered. The calculation is simple.
- The GNPA ratio is the ratio between the total GNPA and the total advances.
- The NNPA ratio is defined as the ratio between the net NPA and the total advances.
Factors that Cause NPAs
NPAs can be caused by a number of factors
- If banks give loans to individuals or businesses without verifying their creditworthiness and despite having a poor rating.
- If lenders do not follow up with borrowers on outstanding payments in a timely manner
- Banks, and especially PSUs, are under pressure to lend money to industries or sectors in need.
- Corruption of financial institutions (lenders) in relation to borrowers (generally businesses).
- Banks’ efficient collection and recovery efforts
How to Prevent NPAs
- When evaluating a business or individual, lenders must check the credit rating of that person or entity.
- Lenders should be proactive and remind borrowers to pay their EMIs.
- Borrowers must be offered payment plans and settlements by lenders to regularize their loan accounts.
- To settle debts quickly, lenders may use other dispute settlement methods such as Lok Adalats or Debt Recovery Tribunals.
- When dealing with large nonperforming assets, lenders should be vigilant and strict.
- Asset reconstruction companies can help lenders better manage their nonperforming loans.
- The lenders must share the information about defaulters with others so that they are hesitant to lend again to them.
- Lenders must adopt policies on insolvency and bankruptcy to assist struggling borrowers.
- Borrowers can use corporate debt restructuring.
- Lenders need to be aware that borrowers, especially corporates, should not send funds (loans) to other subsidiaries or startup companies.
What are the effects of high NPAs on your business?
- A high NPA rate may not be good for a bank as these are non-performing assets.
- The high NPAs mean that the bank has several loans which are nonperforming or do not generate any interest income for the bank.
- The banks can either write off the bad debt or keep it in their books to try and recover it.
- Other factors can be used to evaluate a bank besides NPA.
NPAs can be a burden for the lender. Too many NPAs in a short period could have a negative impact on the bank’s financial health. Lenders should, therefore, take every preventive measure to avoid NPAs. They must also use various options to recover their losses, such as taking over any collateral or selling the loan to a collection agency at a discount.