Non-Performing Assets (NPA)

Learning about NPAs and their effects on lenders. Read to know more about NPA in detail.
Non-Performing Assets (NPA)
3 mins read
26 March 2024

Financial lending institutions play a critical role in the Indian economy. Through loans and other credit facilities, they supply the capital required for businesses to grow and develop. However, despite their crucial contribution to the economy, these institutions are constantly challenged by the threat of NPAs.

Continue reading to learn about the full form of NPA, its various types, and its impact on lending institutions.

What are assets and Non-Performing Assets (NPAs) for a bank

For a bank or any other financial institution, an asset is a financial resource that generates income. Since loans, advances, and other credit facilities provide income to banks by way of interest, they are categorised as assets in the financial statements.

When an asset like a loan stops generating income, it is classified as a non-performing asset or NPA. According to the Reserve Bank of India, banks must classify loans as non-performing assets if repayments for loans or other credit facilities are not made for more than 90 days from the due date.

How do Non-Performing Assets (NPAs) work

Now that you are aware of the meaning of non-performing assets, let us take a closer look at how they work.

Borrowers across the country — whether retail or institutional — avail of loans and credit facilities from financial institutions. When a borrower does not repay the principal and the interest components of such loans for more than 90 days from when they are due, it is automatically classified as a non-performing asset by the lender.

NPAs often have a multi-fold impact on banks and financial institutions. Firstly, a large number of non-performing assets will negatively impact the asset quality, revenue, and profitability of the lender. Moreover, since the funds are locked up in non-performing assets, the entity’s lending capacity decreases significantly. Finally, there is also the possibility of complete write-offs, where NPAs are recorded as a loss in the lender’s books.

Three types of non-performing assets (NPAs)

Non-performing assets can be broadly classified into three major categories depending on how long they have been marked as such by the lender.

  1. Substandard assets
    Assets that remain as NPA for up to 12 months are classified as substandard assets. Although they have significantly higher credit risk, they do have some recovery prospects.
  2. Doubtful assets
    Assets remaining as NPA for over 12 months are classified as doubtful assets. The credit risk of such assets is much higher than that of substandard assets. Their recovery prospects are also very slim.
  3. Loss assets
    Assets with very little recovery value or no recovery prospects are deemed to be loss assets. Banks and financial institutions often write off the entire value of these assets or sell them to asset reconstruction companies (ARCs).

NPA provisioning

Provisioning is a financial risk management technique that is widely used to account for non-performing assets and other extraordinary expenses. Here, financial institutions set aside a portion of their profits to cover the losses that may arise due to non-performing assets.

By setting aside some of their profits to account for NPAs, lending institutions can keep their financial statements clean and write off loans if they become uncollectible. The Reserve Bank of India determines the provisioning norms for banks, which vary depending on the type of NPA, their size, and the location of the lender.

GNPA and NNPA

GNPA is an acronym for Gross Non-Performing Assets. It represents the total amount of NPAs before any provisioning is made.

NNPA, meanwhile, is an acronym for Net Non-Performing Assets. It represents the amount of NPAs in the lender's books after they have made provisions for such losses.

NPA ratios

The Gross NPA Ratio (GNPAR) and Net NPA Ratio (NNPAR) are two of the most commonly used metrics in this category. These ratios provide insights into the asset quality and financial health of financial institutions.

The GNPAR is determined by dividing the gross NPAs by the gross advances (before provisions) made by the bank during a specific period. The resulting figure is multiplied by 100 to arrive at the percentage value.

The NNPAR is determined by dividing the net NPAs by the net advances (after provisions) made by the bank during a specific period. The resulting figure is multiplied by 100 to arrive at the percentage value.

Example of an NPA

Assume a person borrows Rs. 1,00,000 from a bank. According to the terms of the agreement, they need to repay the loan in one year, along with 10% interest on the principal.

However, they default on the payment of monthly EMIs from the very first instalment. About 90 days after the due date, the bank will mark the Rs. 1,00,000 loan as an NPA. The bank can either attempt to recover its dues from the borrower or write it off completely.

Conclusion

With this, you must now be aware of what NPA is and the significant challenges it presents. Financial institutions must manage NPAs effectively to reduce their impact on their balance sheets, maintain financial stability, and sustain growth.

Frequently asked questions

What are non-performing assets?

Non-performing assets are loans or advances that do not generate any income for a financial institution. Loans or advances are marked as non-performing assets if the borrowers fail to make repayments for more than 90 days from the due date.

How do lenders deal with NPA?

Lending institutions adopt a variety of different methods to deal with NPAs. Some of these methods include attempting to recover the pending dues, restructuring non-performing assets, and selling NPAs to asset reconstruction companies (ARCs).

What happens to non-performing assets?

Once financial institutions mark an asset as non-performing, they first initiate steps to recover the pending dues by getting in touch with the borrower. As part of the debt recovery process, the lenders may also offer to restructure the loans in a way that would make repayment easier. This includes waiving off penal interest and increasing the tenure to lower the EMIs. If the debt recovery process fails, financial institutions often sell the NPAs to asset reconstruction companies (ARCs) at a deep discount.

What is an example of a non-performing asset?

A personal loan where the borrower does not repay either the principal or interest for more than 90 days from the due date is a good example of a non-performing asset.

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