All About Non Performing Assets

For aligining with international practices, RBI mandated that most bad debts overdue the period of 90 days is classified as NPA.

In this article on non performing assets, we will be discussing the details of such bad debts. We will also be covering information related to the period of non payment, its types and impact of this class of assets. 

Table of Contents

• What are Non Performing assets?
• How does Non Peforming Assets work?
• Types of NPA
• Points to consider while categorizing NPAs
• Factors determining Non Performing Assets
• Strategies for NPA reduction

What are non performing assets (NPA)?

Non performing asset or NPA refers to a debt instrument. In case of NPA, borrower has not repaid previously agreed upon interest as well as principal to designated lender for extended time period.

Also known as NPA, RBI has defined non performing assets are defined as the loans that are overdue for more than 90 days. A non performing asset is a loss asset for any banking institution since it stops generating any income. When a loan is past its due date yet remains unpaid for a predetermined period is classified as an NPA. Such a bad debt is the loan that is in arrears or in default. These are the loans or advances whose interest or principal has not been on time. These assets are listed on the balance sheet. Any income generated from NPAs is not recognized on an accrual basis and is considered as income only when actually received.

How does Non Performing Assets work?

Let us learn how NPAs work involves looking at their identification, impact, and management.

1. Identification of NPAs

1. Default or Arrears: A loan becomes a non-performing asset when the borrower fails to make the required payments (either principal or interest) for a certain period of time, typically 90 days.
2. Categories of NPAs: NPAs are usually categorized into substandard, doubtful, and loss assets based on the duration of non-performance and the recoverability of the dues:

• Substandard Assets: Loans with payment overdue between 90 days and one year.
• Doubtful Assets: Loans that have remained in the substandard category for a year or longer.
• Loss Assets: Loans with losses identified by the bank, auditors, or the RBI, and considered uncollectible.

2. Impact of NPAs

1. Financial Health of Banks: High levels of NPAs indicate that a significant amount of a bank's funds are tied up in loans that are not bringing in any returns, affecting the bank's profitability and liquidity.
2. Reduced Credit Flow: Banks with high NPAs are likely to be more cautious about issuing new loans, which can reduce the availability of credit in the economy.
3. Banking Sector Stability: Excessive NPAs can lead to a banking crisis, as they erode the financial stability of the banking sector.
4. Economic Impact: The ripple effect of high NPAs can be seen in the broader economy, including slower economic growth and higher interest rates.

3. Management of NPAs

1. Restructuring of Loans: Banks often try to restructure the terms of the loan to make it easier for the borrower to repay.
2. Asset Reconstruction Companies (ARCs): Banks may sell their NPAs to ARCs at a discounted price. ARCs then focus on the management and recovery of these assets.
3. Provisioning: Banks are required to set aside a portion of their profits as a buffer against NPAs, known as provisioning.
4. Recovery Efforts: Legal mechanisms like the SARFAESI Act in India, allow banks to recover NPAs without court intervention.
5. Loan Write-offs: In some cases, banks may write off loans that are deemed irrecoverable, though they may still pursue recovery.
6. Regulatory Oversight: Central banks and financial regulators monitor NPAs closely and may impose certain restrictions or corrective actions on banks with high levels of NPAs.

What do NPAs symbolise?

Non performing assets are the indicators of a number of factors:

• It represents a debt that is no longer an asset and non-payment has gone beyond the period of 90 days.
• Number of NPAs is directly proportional to the decrease in the profitability of the financial institution.
• Increase in NPAs also indicates that the lending capacity has gone down.
• As the number of non performing assets go up, the possibility of loan defaults increases, and so do the write-offs.

Types of Non Performing Assets

A standard asset converts into the following when it continues to be NPA for more than 90 days. The following are different types of NPA:

• Doubtful Assets: It is a type of NPA that does not perform for more than the period of 12 months. Doubtful assets are classified according to the age and extends upto 3 or more years.
• Loss Assets: These are the NPAs that have become uncollectible. They may have little value due to which its continuance as a bankable asset is rejected. If the asset is not written off completely or in parts then it may still have some recovery value.
• Sub standard assets: An asset is identified as a sub standard asset when its due payment date has been passed and it has continued to be an NPA for less than or equal to 12 months. 

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Points to Consider While Categorizing Loans as NPA

Any account must not be outrightly categorised as NPA due to some temporary reasons. The following points must be considered:

• An account in which the regular or ad hoc credit limit is not renewed within the period of 90 days from due date is treated as an NPA.
• Government backed credit facility guaranteed through overview is treated as NPA. This happens when the government denies that its guarantee when invoked. 
• When one facility of a borrower is classified as a non performing asset, then the rest of the facilities of the borrowers must be treated as NPA under the same classification. 
• In case the borrower having cash credit and term loan becomes an NPA, then both cash credit and term loan will be treated as NPA. 

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Factors For Determing Non Performing Assets

Banking institutions are required to make the number of NPAs public through its standalone financial statements. For this purpose, there are two main metrics:

1. Gross NPA (GNPA): Gross non performing asset refers to the total sum of unpaid debt owed to the banking institutions. This means the debtor has failed to fulfil its contractual obligations of repaying principal and interest.
2. Net NPA (NNPA): Net non performing asset is the sum of defaulted loans post deducting provisions for unpaid and uncertain debts. It is a type of allowance for uncertain and poor debts than the number of non performing assets. 

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Strategies to Reduce Non Performing Assets

As with time, the number of NPAs increased, this force the Reserve Bank of India RBI to introduce policies for reducing the number of bad assets. Complete elimination of NPAs is not possible, but they can still be minimised. Every bank is required to have a loan recovery policy which gives the details of strategies to reduce NPA and recover debt loans. While the implementation of the loan recovery policy is essential, do note that it is equally important to monitor these policies at equal intervals.