Non Performing Assets (NPA)

What is NPA?

For a bank, an Non Performing Asset (NPA) or bad debt is usually a loan that is not producing income. Earlier it was largely applicable to businesses. But things have changed with banks widely extending consumer loans (home, car, personal and education, among others) and strict asset classification norms.

If a borrower misses paying his equated monthly installment (EMI) for 90 days, the loan is considered bad, or an NPA. High NPAs are a sign of bad financial health. This has wide-ranging ramifications for a bank, especially in the stock market and money market. So, as soon as a debt goes bad, the banks want it either made better or taken out of their books.

The genesis (origin) of an NPA

There are many reasons as to why a loan goes bad. For a business, it could be because it fails to take off.

Such a situation may arise because of sudden health expenditure or job loss or death. Often, as in the US today, it can be because of over-leveraging, when consumers borrow against most of their assets and, maybe, have unsecured loans too.

In such a case, any hit on income can jeopardize all repayments. They, however, can file for bankruptcy under Chapters 7, 11 and 13 of the United States Bankruptcy Code. Indians don’t have such an option.

In India, the situation has worsened due to banks aggressively pushing loans, even unsecured ones, to individuals to prevent idle assets on their books. President and founder of International Consumer Rights Protection Council, an NGO, says most customers in India are not financially educated and banks are luring them to take more and more loans, often without checking their financial position

Meaning of NPA

An asset is classified as non-performing asset (NPAs) if dues in the form of principal and interest are not paid by the borrower for a period of 180 days. However with effect from March 2004, default status would be given to a borrower if dues are not paid for 90 days. If any advance or credit facilities granted by bank to a borrower become non-performing, then the bank will have to treat all the advances/credit facilities granted to that borrower as non-performing without having any regard to the fact that there may still exist certain advances / credit facilities having performing status.

1) Why such huge levels of NPAs exist in the Indian banking system?

The origin of the problem of burgeoning NPAs lies in the quality of managing credit risk by the banks concerned. What is needed is having adequate preventive measures in place namely, fixing pre-sanctioning appraisal responsibility and having an effective post-disbursement supervision. Banks concerned should continuously monitor loans to identify accounts that have potential to become non-performing.

2) Why NPAs have become an issue for banks in India?

To start with, performance in terms of profitability is a benchmark for any business enterprise including the banking industry. However, increasing NPAs have a direct impact on banks profitability as legally banks are not allowed to book income on such accounts and at the same time banks are forced to make provision on such assets as per the Reserve Bank of India (RBI) guidelines.

Further, Reserve Bank of India (RBI) successfully creates excess liquidity in the system through various rate cuts and banks fail to utilize this benefit to its advantage due to the fear of burgeoning non-performing assets.

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