NPA: Full Form, Types, Impact and Examples

What is NPA?

NPA is defined as the amount of loan or advance the repayment of which has been overdue for more than 90 days. Banks tend to lend money to the borrower, and the borrower is obligated to pay the pre-specified amount of interest along with the repayment of the principal amount. Non-performing assets are always seen as a risk to the bank and institutions, as they do not generate any income and can lead to losses. They are categorised into three types viz. substandard, Doubtful, or loss assets.

Key takeaways from NPA:

• An asset is classified as NPA when the loans or advances have not been repaid by the borrower for at least 90 days.
• NPAs have a significant impact on both the lending institution and the borrower, as they will affect the financial well-being of the lending institution.
• To tackle the problem of increasing NPA, the government and the Reserve Bank of India have introduced various policies and methods to mitigate and reduce the amount of non-performing assets in the banking sector.

Full form of NPA

NPA stands for Non-Performing Asset. An asset is considered a NPA when the loans or advances have not been repaid by the borrower for at least 90 days. In other words, NPAs are loans that do not generate any income for the bank/financial institution because the borrower has failed to make payments of both the principal and interest of the loan, as per the loan schedule, hence they are considered NPA because they are unlikely to become productive again.

Types of NPA

NPA’s are classified under three major heads, viz. Substandard, Doubtful and Loss assets. This recognition of assets is usually drafted after conducting inspections, assessments and audits of these assets in line with guidelines statutory and regulatory guidelines as issued by the Reserve Bank of India RBI).

1. Substandard Assets: These are the assets which have remained NPA for a period less than or equal to 12 months. This category of assets suggests that the borrower has defaulted in the payment of loan, but the asset still has a time period to recover and turn back to be categorised as a performing asset.

2. Doubtful Assets: When a term loan, a lease asset, a hire purchase or any other category of asset has remained in the substandard category for a period of 12 months or more. This category shows that these assets have a high degree of uncertainty and there is a high risk that they might be converted into loss assets. Banks are directed to manage doubtful assets very carefully as they can create loss of an asset.

3. Loss Assets: These are those assets which are considered uncollectible and possess very little value. Although these assets could have some recovery value but they cannot continue as a bankable asset anymore. These assets are required to be written off, and in any case, they are still continued in the books of accounts 100% of the provision is required to be made as the banks have no or low value of collateral available with them.

How NPA Works?

Loans are not classified as NPA category until a considerable period of non-payment has passed. Banks/ Financial institutions have to consider all of the factors that may make a borrower late in making interest and principal payments and extend a grace period or restructure the loan schedule. Once a period of a month or so gets passed after non-payment of loan instalments, banks usually consider a loan overdue. Until the end of the grace period which is typically 90 days in case of non-payment, than only the loan is classified as Non-Performing Asset (NPA). Banks have to take all legal steps and attempt to collect the outstanding debt before foreclosing loan, or the bank has to attach whatever property or asset has been used to secure the loan. Banks use the collateral to pay off the loan and foreclose the loan.

Once the stipulated time period has ended, the bank/ financial institution forces the borrower to liquidate the assets that were pledged as collateral at the time of granting of loan. In case assets are not pledged or no charge on collateral was given to bank, then the bank or financial institution 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 as per loan schedule or at its maturity. In order to summarise the working of NPA following points may be considered:

1. Identification: The first step in the process of non-performing assets (NPAs) is to identify the assets that are not generating returns or are not being serviced at the given time intervals. This is done by the Banks and financial institutions by analysing the loan schedule of the borrower to check the repayment pattern.

2. Reporting: After identification of non-performing assets, Banks and financial institutions need to report to the regulatory authorities. This is done by the Banks and financial institutions in the form of a report that contains all the details of the non-performing assets.

3. Classification: The assets are then classified according to the default period so that they can be categorised as which type of NPA category they fall in. This step makes sure that the bank and financial institutions are able to properly identify the assets and take appropriate steps.

4. Provisioning: The Banks and financial institutions need to make provisions for the NPAs in case of default. They make a provision against the assets and set aside a certain amount of money to cover the possible loss. RBI has provided guidelines on the amount of provision required for all individual categories.

5. Recovery: The next step is to try and recover the dues from the borrower if possible. Banks can either negotiate with the borrower or take legal action to recover the dues. In case any dues get recovered they have to inform the regulatory authorities about such recovery and the source of recovery as well.

6. Resolution: If no dues get recovered, then the lenders can opt for resolution or reconstruction.

Example of NPA

Suppose Mr. X takes a loan of ₹1,00,000 from ABC bank on 15th Jan, 2023. Bank provided the scheme of paying ₹12,000 per month for the next 10 months, out of which ₹10,000 will be principal and ₹2000 will be interest. Installment will fall on every 15^th day of the month. Mr. X serviced the first three instalments on time i.e. he paid the installment of 15^th February, 15^th March and 15^th April. But later due to loss in business, he was unable to service the installment payment for the loan taken. So since, 15^th May, he has failed to pay any instalment towards the loan. So once a period of 90 days has passed from the receipt of the last installment bank will consider this loan as a non-performing asset. Further, Mr. X loan will be categorised as follows:

1. Substandard Asset: In case Mr. X does not pay his loan in the next 12 months, i.e. 15^th April 2024.

2. Doubtful Asset: In case Mr. X does not pay his loan even after more than 12 months have passed since the last receipt of the instalment, i.e., 15^th April, 2024.

3. Loss Asset: In case when no dues from Mr. X can be recovered by the bank after all arrangements. His loan will be written off.

Impacts of NPA

I. Impact on Borrower

• Reduced CIBIL Score: The NPA is considered only when the borrower is not able to pay back the dues, which ultimately impacts the borrower’s creditworthiness, which reduces their CIBIL score and nowadays banks prefer to give loans only to those borrowers who possess good CIBIL score.
• Brand Image: Any default in paying back the loan impacts the goodwill of the borrower.
• Future Funding Issues: In future, Banks will be apprehensive about sanctioning a loan to a borrower whose account is an NPA.
• Impact on other Group Entities: In case a subsidiary or sub-subsidiary company makes a default in repayment, NPA does not only impact the primary borrower but also the other group entities.

II. Impact on Banks and Financial Institutions

• Profitability: Any rise in NPA directly affects the bank’s profits. The greater the value of NPA, the less will be the profits generated by the bank or institution.
• Liability Management: In order to maintain the NPA figure, Banks have to lower deposit interest rates. At the same time, it increases the lending rates for other advances, which directly affects the bank’s business.
• Portfolio Contraction: A higher NPA results in a lower rate of fund rotation as the pre-invested assets either get written off or earn lower than the expected returns which affects the bank’s portfolio.
• Capital Adequacy: The greater the amount of NPA, the greater will be the amount of capital induction requirement, which will raise the capital costs.
• Provision Creation: When NPA arises, as per the guidelines of RBI, banks are required to make a certain percentage of provision for each category of NPA classification. This leads to unwanted blockage of funds.

How to Reduce NPA?

India has recorded a 10-year low of bad loans in the year 2023, which reveals that India is taking appropriate steps to reduce NPAs. There is a strict requirement to control NPA’s as they ultimately affect the economy and market at large. India has taken significant steps to eliminate the NPA and the process is progressing. Some of the ways India has adopted to reduce NPAs are as follows:

1. Creation of Debt Recovery Tribunal (DRT), 2013: DRT was set up to reduce the time required for settling cases. It is governed by the Recovery of Debt due to the Banks and Financial Institutions Act, 1993. DRT has managed to contribute to reducing and monitoring NPA’s over time.

2. Strategic Debt Restructuring (SDR), 2015: All those Corporations who have taken loans from banks if they are unable to repay, then the banks will have the option to convert part or complete loans into equity shares

3. Asset Quality Review, 2015: This is a kind of preventive measure which involves early identification of assets which could turn out to be stressed at a later stage. Asset quality review is an exercise conducted by RBI where the assets of the banks are studied and advised about the steps required ahead.

4. Mission Indradhanush, 2015: It is one of the most comprehensive reforms undertaken by government authorities to improve the functioning of the Public Sector Banks, by using the ABCDEFG formula. In this action plan, the aim is to revamp all public sector banks and deploy modern tech which can identify red flags and identify areas of concern in the loans and advances made by banks.

5. Corporate Debt Restructuring, 2005: CDR Reduces the burden of debts on the company by allowing them more time to pay back as well as decreasing the rates along with it.

Limitations of NPA

1. Poor Credit Risk Management: Poor credit risk management is one of the main reasons for the rise of non-performing assets. Banks and financial institutions need to effectively assess and monitor the credit risk of their customers in order to avoid non-performing assets.

2. Economic Slowdown: Poor economic conditions of customers can affect their ability to repay their debts, which leads to non-performing assets.

3. Regulatory Changes: Regulatory changes in the market can affect the ability of customers to repay their debts, which leads to non-performing assets.

4. Interest Rates: Charging high-interest rates can lead to non-performing assets as debtors may be unable to meet repayment terms in case of high interest rates.

5. Fraud: Fraudulent activities can also result in non-performing assets. Banks and other financial institutions need to effectively monitor and detect fraud and should perform due diligence before advancing any loan to any lender.

Conclusion

Non-performing Asset refers to those loans or advances that have not been serviced by the borrower for at least 90 days. In other words, NPAs are loans that do not generate any form of income for the bank or financial institution because the borrower has failed to make payments on both the principal and interest of the loan. NPAs are a major concern for banks and financial institutions as they can impact their profitability and financial well-being. Non-performing assets are always seen as a risk to the bank and institutions, as they do not generate any income and can lead to losses. They are categorised into three types viz. substandard, Doubtful, or loss assets.