What are Non-performing assets?
Loans or advances in default or arrears are known as non-performing assets (NPAs). Debt is in arrears when the principal or interest payments are late or missed. The loan defaults when the lender thinks the terms have been broken and the borrower cannot fulfil his obligations.
While some lenders consider a loan or advance past due sooner, loans generally become NPAs when unpaid for 90 days or more.
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Non-Performing Assets”
What does a bank’s asset mean?
Anything owned is referred to as an asset. Because the interest we pay on these loans is one of the bank’s most important sources of income, a loan is an asset for banks. The asset for the bank becomes “non-performing” when corporate or retail customers cannot pay the interest since it is not producing any income for the bank. The RBI, therefore, defines NPAs as assets that stop producing income for them.
Categories of Non-Performing Assets (NPAs)
Usually, a grace period is given by lenders before declaring an asset as non-performing. The lender or bank will then classify the NPA into one of the subsequent sub-categories:
Standard Assets
They are NPAs with a usual risk level that has been past due for 90 days to 12 months.
Sub-standard Assets
They are NPAs that have more than a year’s worth of past-due balances. They have a significantly increased risk level in addition to a borrower with bad credit. Because they are less certain that the borrower will ultimately return the full amount, banks typically reduce the market value of such NPAs.
Doubtful Debts
Non-performing assets at least 18 months past due are included in the category of questionable debts. Generally, banks have major concerns about the borrower’s ability to return the entire debt. This category of NPA significantly impacts the bank’s risk profile.
Loss Assets
These non-performing assets have a prolonged history of unpaid bills. Banks must accept this class and report a loss on their balance sheet since the loan will never be repaid. The loan must be wiped off in its entirety.
The Operation of Non-performing Assets (NPA)
The balance sheet of a bank or other financial organization includes non-performing assets. After an extended period of non-payment, the lender may require the borrower to liquidate any assets pledged as a loan condition. If no assets were pledged, the lender might write off the asset as a bad debt and then sell it at a loss to a collection company.
Most of the time, debt is classified as nonperforming after 90 days or more of missed loan payments. While 90 days is typical, the actual period may vary depending on the terms and circumstances of each specific loan, either shorter or longer. At any time before or after the loan’s maturity, it may be designated as a non-performing asset.
To comply with regulatory standards, the lender can be forced to classify the loan as non-performing. A corporation can also label a loan as non-performing if it makes all the interest payments but cannot pay back the principal when it is due.
When non-performing assets, often referred to as nonperforming loans, are included on the balance sheet, the lender is left with a significant burden. The lender’s cash flow is reduced when interest or principal are not paid, which can cause budgetary problems and lower revenues. Loan loss provisions, which are set aside to cover potential losses, limit the capital available to make more loans to other borrowers.
Realized losses from defaulted loans are computed and subtracted from revenues. If a bank accumulates significant NPAs on its balance sheet over time, regulators can tell that the bank’s financial viability is in threat.
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Different Non-performing Assets (NPA)
Term loans are the most common non-performing asset, although there are other kinds.
- Overdraft and cash credit (OD/CC) accounts that have not been used for more than 90 days.
- Agricultural loans whose interest or principal instalment payments are two crop/harvest seasons or one crop season past due for crops with short growing seasons.
- Expected payment is more than 90 days past due on any other account.
Contributing factors for NPAs
- Banks lend to untrustworthy individuals, businesses, and other entities that take significant risks.
- Understanding their bank’s capital and loan loss reserves at a given time does not help banks reduce their losses;
- The promoter of businesses that divert money to other purposes;
- banks funding unprofitable initiatives;
- Public sector banks began to suffer from severe capital shortages and losses in the early 1990s. The goals they set for themselves did not anticipate the greatest necessity for these business objectives.
Non-performing Assets (NPA) Provisioning Standards
Standards for provisioning are established by the Reserve Bank of India and are the same for all banks about NPA (NPA in Banking). They may vary to some extent depending on the NPA category. These are listed below:
- 10% of the appropriate allowances for the total amount owed, without any budgeting for securities or other forms of government assurance.
- The NPA within the subpar category would increase the coverage by an additional 10%, for a total of 20% on the outstanding balance.
- A dubious or unsecured NPA is defined as having a 100% provisional requirement.
NPAs’ Effect on Operations
- It lowers the bank’s earnings.
- It affects the bank’s capital sufficiency.
- As a result, the banks stop making loans and assume no risk. As a result, new credit is not produced.
- Instead of increasing bank profitability, the banks began focusing on credit risk management.
- The cost of funds becomes higher due to NPA.
Prevention Techniques
- Examining a person’s or a company’s Credit Information Bureau (India) Limited (CIBIL) rating before making a loan.
- Various settlement methods can be used, or a compromise can be obtained.
- Utilise other dispute resolution processes, such as Lok Adalats and Debt Recovery Tribunals, to hasten the payment of debts.
- Actively spread information about defaulters.
- Take firm action against significant NPAs.
- Asset Reconstruction Company is to be used.
- Legal reforms have been implemented, like the Insolvency and Bankruptcy Code.
- Restructuring of Corporate Debt (CDR).
- Setting rules for intentional financial theft and defaults.
Measures to control Non-performing Assets
Credit Risk Control
The project’s creditworthiness, clients’ knowledge and experience should all be sufficiently assessed. In addition to these assessments, banks should perform sensitivity studies and develop safeguards against external factors. A solid management information system (MIS) must be put in place to monitor project early warning indications. In a perfect world, the MIS would spot issues and immediately alert management to address them.
Asset Reconstruction Company
An ARC or asset management business must be established to hasten the settlement of PSBs’ stressed assets. The government should take the required steps to look into the feasibility after carefully weighing the pricing and capital challenges.
Sarfaesi Act, 2002
Using asset reconstruction, security enforcement, and securitization as alternatives to going to court, the SARFAESI offers banks three ways to deal with non-performing assets (NPAs). SARFAESI can handle any unpaid debt greater than Rs. 1 lakh. However, the Act does not recognize a sum less than 20% of the principal and interest sum. The Act also permits banks to notify you (as well as your guarantor) and ask that the money be released within 60 days of receiving the notification.
More stringent NPA Recovery
Laws must be modified to provide banks with more power to recover NPAs. The Insolvency and Bankruptcy Code has caused discipline because people fear losing their assets. Due to debtor control amendments to the Banking Regulation Act, the RBI can inspect a lender but does not have the power to create an oversight committee.
The RBI has asked for nine more powers under the Banking Regulation Act concerning PSBs, including the ability to appoint and remove CMDs, change the Board of Directors, apply for the winding up of troubled banks, approve voluntary amalgamation proposals, and more.
Accountability
Minor mistakes are frequently the responsibility of young executives, whereas significant decisions are made by the Credit Sanction Committee, composed of senior-level executives. It is essential to hold senior executives accountable if PSBs are to handle NPAs.
Corporate Responsibility
Corporate governance hasn’t improved to the expected level despite the government creating the Banks Board Bureau in April 2016 to attract talent. Key issues still need to be addressed immediately.
How can NPA in Indian banks be reduced?
The bank ought to thoroughly investigate the business it is lending money to. Loans to failed companies will prevent enough money from being available for outstanding investments. Making the defaulters’ name list available to the public is preferred. This instils a sense of fear and acts as a deterrent.
After making a loan, the bank should keep an eye on the company’s performance and be able to predict whether it will eventually fail. The bank will therefore liquidate the assets before the loans stop being serviced.
Importance of NPAs
It’s critical for both the borrower and the lender to understand the difference between performing and non-performing assets. If the asset is non-performing and interest payments are not made, it may harm the borrower’s credit and growth prospects. It will subsequently make it more difficult for them to borrow money.
The major source of income for the bank or lender is interest from loans. As a result, non-performing assets will harm their capacity to provide sufficient income and, consequently, their overall profitability. Banks must monitor their non-performing assets because having too many NPAs will negatively impact their liquidity and capacity for expansion.
Depending on how many there are and how far they have fallen behind on payments, non-performing assets may be controllable. Most banks can take on a reasonable number of NPAs in the short run. However, the lender’s financial stability and future prosperity are in jeopardy if the number of NPAs increases over time.
Conclusion
A bank may not benefit from having high NPAs. This is because they are underperforming assets. High NPAs indicate that a bank has excessive loans that are either no longer operational or are not generating any interest income. In the hopes of someday recovering it, banks can either maintain NPAs on their books or make provisions for them. Otherwise, banks completely write off the loans as bad debt. NPA is only one of many criteria to evaluate a bank.
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Frequently Asked Questions(FAQs)
- What distinguishes non-performing assets (NPAs) from bank fraud?
Ans: Banks have long been plagued with non-performing assets. The government of India and the Reserve Bank of India have redoubled their efforts to address the issue of non-performing assets.
There is a distinction between NPA and bank fraud:
Bank fraud is a crime; non-performing assets are loans or advances when the interest or principal instalments are 90 days past due.
According to the Reserve Bank of India (RBI), an asset stops producing income for the bank when it does so. The non-performing assets in public banks are estimated to be about $ 62 billion, or 90% of all non-performing assets in India.
- What effects do non-performing assets have?
Ans: Non-performing assets have the following effects –
- Banks won’t have enough money for additional development initiatives, affecting the economy.
- Banks will be compelled to raise interest rates to preserve a profit margin.
- The reduction in new investments could result in a rise in unemployment.
- What are some examples of non-performing assets?
Ans: Residential mortgages, home equity loans, credit card loans, non-credit card outstandings, direct and indirect consumer loans, and more could all fall under non-performing assets (NPAs).
- What causes NPA?
Ans: Inadequate loan management practices, inaccurate credit assessments, business failures, poor receivables recovery, a slow-moving legal system, an industrial recession, unfavourable currency rates, and other reasons contribute to NPA.
