Non Performing Assets of Banks

Sarasij Majumder

Definition: A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period over 90 days.
Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets, as explained below.
1. Substandard assets: Assets which has remained NPA for a period less than or equal to 12 months.
2. Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
3. Loss assets: As per RBI, “Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value.”

The NPA meaning in banking is any asset that fails to perform and cannot generate revenue for the bank. Loans are assets for banks as the interest that the borrower pays to the bank is their source of income. Any consumer who fails to pay the interest is categorised as “non-performing” by the bank as they fail to meet their obligations. 

When a non-payment of interest arises, the borrower is forced to liquidate any assets pledged as a part of the debt agreement. 

Nonperforming assets are listed on the balance sheet of a bank or other financial institution. After a prolonged period of non-payment, the lender will force the borrower to liquidate any assets that were pledged as part of the debt agreement. If no assets were pledged, the lender might write-off the asset as a bad debt and then sell it at a discount to a collection agency, generally termed as “ BAD BANK”.

In most cases, debt is classified as nonperforming when loan payments have not been made for a period over 90 days. While 90 days is the standard, the amount of elapsed time may be shorter or longer depending on the terms and conditions of each individual loan. A loan can be classified as a nonperforming asset at any point during the term of the loan or at its maturity.

For example, assume a company with a $10 million loan with interest-only payments of $50,000 per month fails to make a payment for three consecutive months. The lender may be required to categorize the loan as nonperforming to meet regulatory requirements. Alternatively, a loan can also be categorized as nonperforming if a company makes all interest payments but cannot repay the principal at maturity.

Carrying nonperforming assets, also referred to as nonperforming loans, on the balance sheet places significant burden on the lender. The nonpayment of interest or principal reduces the lender's cash flow, which can disrupt budgets and decrease earnings. Loan loss provisions, which are set aside to cover potential losses, reduce the capital available to provide subsequent loans to other borrowers. Once the actual losses from defaulted loans are determined, they are written off against earnings. Carrying a significant amount of NPAs on the balance sheet over a period of time is an indicator to regulators that the financial fitness of the bank is at risk.

NPA Provisioning

Provisioning is a method that banks employ to maintain a healthy book of accounts. Apart from technicalities, it is the primary responsibility to make adequate provisions for any drop in the value of loan assets. In a particular quarter, banks set aside a specific amount of profits for non-performing assets that may turn into losses in the future. Not only is the type of asset different, but the provisioning also varies from bank to bank. 

For example, a Tier I bank's provision norms will differ from those of a Tier II bank. The inspecting officer of the RBI and statutory auditors make the assessment. They assist the bank's management in making adequate and necessary provisions by prudential guidelines.

A higher number of NPAs indicates the dysfunctionality of loans and a decrease in the income of the banks. Therefore, calculating absolute numbers regularly can help in understanding the current situation of the bank. Two metrics determine the number of NPAs.

●    GNPA: GNPA stands for Gross Non-Performing Asset. This number denotes the total value of NPA in a quarter or a financial year. It is obtained by adding all the principal amount and interest on that amount.

●    NNPA: NNPA is Net Non-Performing Asset. The provision made by the bank is deducted from the GNPA. It is the exact value obtained after the bank has made provisions for it.

Following ratio denotes the total percentage of the unrecoverable total advances. Amounts advanced are the total outstanding amount.

1.    GNPA Ratio: It is the ratio of Gross NPA to Gross Advances
2.    NNPA Ratio: It is the ratio of Net NPA to Net advances 

According to a report by India Ratings (Ind-Ra), an  affiliate of Fitch, Banks'  NNPA in Last FY was 1%, and GNPA was 4%. For PSU Banks, GNPA has dropped from 145 to 5%, however, this may be due to writing off some BAD LOANS.

Impact of NPA on Operations

NPA is not favourable for any bank. Higher NPA numbers are quite alarming and raise questions about the banking system. It drastically impacts the work, and the following are some prominent ones:

●    Profitability

It directly affects the bank's profits. The greater the value of NPA, the less profit the institution produces.

●    Liability management

Banks have to lower deposit interest rates to maintain the NPA figure. At the same time, it increases the lending rates, directly affecting the bank’s business. 

●    Asset contraction

A higher NPA results in a lower rate of fund rotation.

●    Capital adequacy

The greater the NPA, the greater the amount of capital induction needed, which raises capital costs.

●    Public confidence

NPA undermines banks' soundness and creates fear among the public to conduct any business with the bank as its liquidity is at risk.

REALITY

 It is now time to accept the reality that NPAs are inevitable, they will occur and they need to be addressed. In this regard, I must appreciate the recent unflinching action by the Reserve Bank of India (RBI) in terms of conducting a stress test at the individual bank level, though the outcome has not been made public, leaving banks with the option to recognise and provide for. While this provisioning might cause some near term jitters, in the long run it will be good for the system. Especially, considering the fact that old problems, and not new ones, are a major contributor to asset quality issues.

It is a right step that FM and the RBI are in sync. and both recognise that stress recognition is inevitable.

Solution

 asset reconstruction companies (ARCs) and distressed funds will take on a critical role of providing revival or resolution solutions. In the past ARCs were part providers of risk capital and partly recovery agents for the banks. However, now the need may shift to larger amounts of risk capital to be made available by ARCs through distressed funds and strategic buyers. Also post the NPA recognition, banks would carry these assets at a more realisable value in their books. The significance of ARCs can be gauged from the fact that together ARCs have acquired bad loans worth less than Rs 1 lakh crore till date, forming less than 2% of overall banking credit. However, this percentage appears relatively low when compared to over 10% of total stress (Gross Non performing Loans plus restructured) already being reported by banks.

The reason for this is two-fold, first higher cash contribution required by ARCs and second the lack of clarity with banks on the true realisable value of the asset. However, I believe this will now get resolved as banks will now be able to carry assets at real value on their book which will allow them to sell down assets relatively easily, and ARCs will be able to offer realistic resolution.

Sources:-- MINT, FE, FT, REPORTS of RBI.