Lending money is how banks earn a living. But what happens when that money doesn’t come back? When borrowers stop paying, banks lose income, and that’s where Non-Performing Assets (NPAs) enter the picture. These unpaid loans pile up and put pressure on banks—slowing down lending, hurting profits, and sometimes threatening the bank’s financial health.
In India, NPAs are a growing concern for both public and private lenders. Whether it's because of business failure, bad credit assessment, or borrowers simply walking away, NPAs can derail a bank’s operations. And because the economy relies on smooth credit flow, managing NPAs is crucial to keeping the financial system stable.
In this guide, we’ll explain what NPAs are, how they’re classified, what causes them, and why both banks and borrowers should care. You’ll also learn how NPAs affect profitability, balance sheets, and public trust in financial institutions.
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What is a Non-Performing Asset?
A Non-Performing Asset (NPA) is a loan or advance given by a bank or financial institution that hasn’t been repaid for more than 90 days. Once a borrower stops paying interest or principal for three months or more, the bank marks the loan as a non-performing asset.
Why does this matter? Because that loan stops generating income for the bank. The longer it stays unpaid, the harder it becomes to recover. Whether it’s a home loan, business credit, or a large infrastructure loan—if the money’s not coming back, the bank calls it an NPA.
The Reserve Bank of India (RBI) adopted the 90-day rule in 2004 to bring India’s banking standards in line with global norms. Once a loan is tagged as NPA, the lender must start tracking and reporting it, and possibly take legal steps to recover the dues or write it off.
How do non-performing assets work?
Now that you know what NPAs are, let’s understand how they actually work in real life.
When individuals or companies take loans from banks—whether for homes, business expansion, or other needs—they’re expected to repay in monthly instalments. But if the borrower misses those payments for 90 days or more, the loan becomes a non-performing asset in the bank’s records.
This triggers a chain reaction. First, the bank loses interest income from that loan. Then, it must mark the asset as risky, which affects its balance sheet. Worse still, if there are too many NPAs, the bank’s ability to issue new loans goes down significantly. It now has money locked in unrecoverable loans—and may need to write them off entirely if the borrower defaults completely.
So, even one unpaid loan doesn’t just affect the borrower—it affects the bank’s financial health, lending capacity, and public confidence.
Types of Non-Performing Assets (NPA)
Not all NPAs are equal. Banks categorise them based on how long the borrower has failed to repay:
A. Substandard Assets
These are loans that have remained unpaid for less than 12 months. Though still risky, they may have some chance of recovery if action is taken early.
B. Doubtful Assets
Loans that remain unpaid for over 12 months fall into this category. The chance of recovering the full amount is low, and the credit risk is much higher.
C. Loss Assets
These are loans where the bank has almost no hope of recovery. Most of the time, they’re either written off or sold to Asset Reconstruction Companies (ARCs) at a discounted value.
Each classification helps banks track the risk level and take appropriate recovery or write-off actions.
What are the causes of NPA?
NPAs don’t just appear out of nowhere. They usually stem from a mix of economic, institutional, and borrower-level issues:
- Economic slowdowns: When businesses don’t perform due to recession or reduced demand, loan repayments often stop.
- Fraudulent borrowers: Some borrowers take loans with no intention of repaying.
- Lax credit checks: Banks sometimes approve loans to people or companies without verifying their creditworthiness properly.
- Poor monitoring: Once the loan is issued, weak follow-ups can result in delayed detection of defaults.
- Interest rate hikes or price drops: Economic shifts can also affect repayment abilities—especially for loans tied to commodities or exports.
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Understanding these causes is crucial because it helps both banks and policymakers strengthen lending practices and avoid future defaults.
Importance of NPAs
Why are banks so worried about NPAs? Because they’re a direct reflection of a bank’s health.
A high number of NPAs means that a big chunk of the bank’s loans isn’t earning any income. That not only hits profitability but also affects liquidity, credit growth, and investor confidence. The capital adequacy ratio, a key measure of a bank’s financial strength, can also take a hit.
By regularly tracking NPAs, banks can spot lending issues early, tighten credit checks, and avoid bigger losses in the future. For investors, regulators, and depositors, NPA levels serve as a key indicator of whether the bank is managing risk well or not.
NPA Provisioning
When a loan turns bad, banks can’t just ignore it. They need to prepare for the possible loss—and that’s where provisioning comes in.
Provisioning means setting aside a part of the bank’s profits to cover potential losses from NPAs. This makes sure the bank doesn’t overstate its profits and can absorb financial shocks without collapsing.
The RBI sets rules on how much needs to be provisioned, and the amount varies based on the type of asset, the risk level, and the location of the bank. By provisioning wisely, banks can keep their books clean and maintain trust with investors and regulators.
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GNPA and NNPA
Two common terms used to evaluate NPA levels are:
- GNPA (Gross Non-Performing Assets): This is the total value of all bad loans before any provisions are made. It shows the full scale of the problem.
- NNPA (Net Non-Performing Assets): This is the value of NPAs after deducting the provisions. It reflects the actual financial impact of bad loans on the bank’s books.
GNPA and NNPA are often used in ratio form to measure how risky a bank’s loan book is. If the NNPA ratio is too high, it means the bank hasn’t set aside enough cushion to handle loan defaults.
NPA Ratios
NPA ratios help you quantify how bad a bank’s bad loans really are. Two ratios matter most:
Gross NPA Ratio (GNPAR)
This shows what portion of the bank’s total advances have turned into NPAs—before making any provisions.
Formula:
Gross NPA Ratio = (Gross NPAs / Gross Advances) × 100
Net NPA Ratio (NNPAR)
This measures NPAs after provisions have been made. It reflects the actual stress on the bank’s earnings.
Formula:
Net NPA Ratio = (Net NPAs / Net Advances) × 100
Both ratios are closely monitored by regulators and analysts. A high GNPAR or NNPAR usually signals poor asset quality, higher risk, and possibly tighter regulations ahead.
Example of an NPA
Let’s say someone borrows Rs. 1,00,000 from a bank, to be repaid in 12 monthly instalments with 10% interest.
But the borrower misses the very first payment and doesn’t pay for the next 90 days either. As per RBI norms, once the loan remains unpaid for over 90 days, the bank flags it as a non-performing asset.
At that point, the bank has two options:
- Try to recover the amount from the borrower
- Or mark the loan as a loss and write it off
This is how even one missed EMI can lead to an NPA classification—and its why early repayment tracking is so important.
Management of NPA
Banks can’t afford to wait forever for repayments. So when a loan becomes an NPA, they take action.
Here’s how they manage it:
- Early warning systems: Spotting signs of stress before a loan defaults.
- Loan restructuring: Adjusting interest rates, extending repayment timelines, or reworking terms to help borrowers repay.
- Legal routes: Using the SARFAESI Act, Debt Recovery Tribunals (DRTs), or the Insolvency and Bankruptcy Code (IBC) to recover dues.
- Asset Reconstruction Companies (ARCs): Selling bad loans to third parties who try to recover what they can.
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Advantages of NPA classification
It might seem negative at first, but identifying and classifying NPAs actually helps banks in several ways:
- More transparency: NPAs give a clearer picture of the bank’s real loan book and risk levels.
- Timely action: Once a loan is flagged, banks can restructure or pursue recovery quickly.
- Regulatory compliance: It ensures the bank is following RBI norms, which builds long-term credibility.
- Better decisions: Investors, analysts, and management can use NPA data to assess risk and make smarter financial choices.
In short, proper NPA classification helps banks act faster, stay compliant, and make informed moves.
Challenges associated with NPAs
NPAs are more than just unpaid loans—they cause ripple effects across the entire banking system:
- Lower profits: Banks earn no interest on NPAs, and that hits their income directly.
- Heavy provisioning: Money must be set aside to cover expected losses, reducing net profits.
- Limited lending: With funds locked in bad loans, banks hesitate to lend more.
- Operational strain: Recovery is often time-consuming and complex, involving legal procedures.
- Investor nervousness: High NPA levels can shake market confidence and drag down share prices.
- Regulatory pressure: More NPAs invite stricter supervision and compliance checks from the RBI.
Simply put, NPAs can drag down a bank’s earnings, trust, and agility—making their management non-negotiable.
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What is the Gross NPA Ratio?
The Gross NPA Ratio gives you a quick snapshot of a bank’s loan book health. It tells you how much of the bank’s total lending has turned bad.
Formula:
Gross NPA Ratio = Total Gross NPAs / Total Assets × 100
Gross NPAs are loans that have been overdue for more than 90 days. Total assets include all of the bank’s holdings—loans, cash, and investments.
If this ratio is rising, it means more loans are going unpaid, which could mean trouble. A bank with a high Gross NPA Ratio might face tighter regulations and lose market trust.
What is Net NPA?
While Gross NPAs show the total amount of bad loans, Net NPA goes a step further. It subtracts the provisions banks have made to cover those losses. This gives a more realistic view of how much damage NPAs could actually do.
Formula:
Net NPA = Gross NPAs – Provisions
Net NPA shows the real financial burden that bad loans put on a bank. If it’s too high, it means the bank hasn’t set aside enough backup money and could be vulnerable to shocks.
This number is especially important to regulators, rating agencies, and investors when assessing a bank’s risk exposure.
Significance of NPAs
NPAs are more than just a banking term—they directly affect both lenders and borrowers.
For borrowers, defaulting on a loan can damage their credit score and make it harder to get future financing. It can also affect their reputation in business or personal circles.
For banks, NPAs reduce income and force them to cut back on new lending, which hurts economic growth. Since banks rely on interest income, any loan that stops paying back is a serious red flag.
Monitoring NPAs closely helps banks stay stable and helps regulators ensure that the entire financial system isn’t put at risk. In short, keeping NPAs low is crucial for trust, stability, and long-term growth.
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Factors that can lead to NPA
Many internal and external triggers can push loans into NPA territory. Some of the most common causes include:
- Poor financial planning: Borrowers may take on more debt than they can handle.
- Business failure: Economic downturns, poor management, or market shifts can sink even well-funded businesses.
- Weak credit assessment: Banks may approve loans without properly vetting the borrower’s financial health.
- Fund misuse: When borrowers use loans for purposes other than what they were sanctioned for, repayment often suffers.
- Delayed project execution: Especially in infrastructure loans, slow execution affects cash flow and repayment.
- Natural calamities: Floods, droughts, or pandemics can disrupt earnings, especially in agriculture.
- Willful default: Some borrowers choose not to repay despite having the means.
Each of these factors highlights the critical importance of due diligence, ongoing monitoring, and responsible borrowing.
Impact of Non-performing assets on operations
The consequences of NPAs stretch beyond balance sheets. They ripple through operations and reputation:
- Financial stress: Interest income drops while provisioning needs rise.
- Tightened lending: High NPAs force banks to pull back on issuing new loans.
- Regulatory heat: More NPAs mean more oversight, reporting, and sometimes restrictions.
- Loss of investor trust: If NPA levels stay high, share prices may drop, and market credibility takes a hit.
Ultimately, NPAs are not just about numbers—they shape the bank’s future capacity to function and grow.
Key Takeaways
- NPAs are loans unpaid for more than 90 days.
- Substandard (up to 12 months), Doubtful (over 12 months), and Loss Assets (minimal recovery).
- Reduce income, increase provisioning, and limit new lending.
- Gross and Net NPA ratios reflect the real financial exposure.
- Banks must follow RBI norms to set aside funds for potential losses.
Conclusion
Non-Performing Assets are one of the biggest challenges banks face today. Whether caused by economic issues, poor lending practices, or borrower defaults, NPAs weaken the financial backbone of lending institutions.
But with better monitoring, early intervention, and strong legal frameworks like the IBC, banks can recover and grow stronger. For the financial system to remain resilient, both borrowers and lenders must understand the risks, responsibilities, and impact of NPAs.
In the long run, managing NPAs isn’t just about recovery it is about rebuilding trust, ensuring stability, and supporting growth.
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