May 15 • 3 mins read
What Is Non-Performing Asset (NPA): Types of NPA, Its Impact and More
What Is Non-Performing Asset (NPAs)?
A non-performing asset (NPA) is a loan or advance in default or in arrears as the principal or interest payment is overdue for 90 days.
The RBI, in a 2007 circular said, “An asset becomes non-performing when it ceases to generate income for the bank.”
Classifications for Non-Performing Assets (NPAs)
The below table gives the different classification of non-performing assets:
|Classifications for Non-Performing Assets||Criteria|
|Substandard assets||These assets have remained NPA for a period less than or equal to 12 months.|
|Doubtful assets||These are assets that have remained in the substandard category for a period of 12 months or more.|
|Loss assets||These assets are considered uncollectible and of very little value. Although these assets could have some recovery value, they cannot continue as a bankable asset.|
How Non-Performing Assets (NPA) Work?
After a prolonged period of default, the lender forces the borrower to liquidate the assets that were pledged as collateral in the debt agreement. If assets were not pledged, then the lender writes it off as bad debt and sells it to a collection agency at a discount. A loan can be classified as a non-performing asset at any point during the term of the loan or at its maturity.
An example: Let’s assume that a company took a loan of ₹ 20 million. If the company fails to pay the interest ₹100,000 per month for three consecutive months, the lender categorises this loan as non-performing asset, listing it as an NPA on its balance sheet. A loan can also be categorised as non-performing if a company makes all interest payments but fails to pay off the principal at maturity.
Why Do Banks Worry About an Account Turning Into an NPA?
There are numerous reasons why banks worry about their accounts turning into NPAs, but we’ll discuss the major ones:
- Revenue Loss: When an account turns into an NPA, it become a stressed account, and banks have to stop charging interest on it.
- Brand Image: A higher number of NPAs reflects badly on the image of the bank.
- Higher Provisions: The RBI imposes a certain set of rules on the banks to make provisions at a higher rate if an account turns into NPA.
- RBI Action: In some cases, the RBI may take harsh actions.
- Stock Market Crash: The bank’s stock market prices may fall if it’s listed with NPAs.
What Are the Impacts of Non-Performing Assets (NPA)?
When accounts turn into NPAs, the impact is as follows:
- Banks do not have sufficient funds for other development projects, thus impacting the economy.
- The curb in further investments may lead to the rise of unemployment.
- Banks are forced to increase interest rates to maintain a profit margin.
Impact of NPA on Borrowers
- CIBIL Score: The NPA impacts the borrower’s creditworthiness, thus hurting their CIBIL score.
- Brand Image: An NPA impacts the goodwill of the borrower.
- Future Funding Issues: Banks will be apprehensive about sanctioning a loan to a borrower whose account is an NPA.
- Impact on other Group Entities: An NPA doesn’t only impact the borrower but also the other group entities.
NPAs are not favourable for banks as they are non-performing. A high number of NPAs means that too many loans have become non-functional or are not generating any interest income for the bank. However, the banks have the choice to either keep the NPAs in their books, hoping that they will recover or make provisions for them. Or, they can write it off entirely as a bad debt. NPAs in India have grown in the last few years and are impacting the economy. Therefore, it is the need of the hour for government and banks to improve their practices to arrest the growth of NPAs.