Non-Performing Assets (NPA) - Meaning, Types & Examples

Every industry has its specific terminologies. So is the case with banking. In the banking industry, bankers often mention Non-performing Assets, or an NPA. Non-performing assets for a bank are the loans on which the principal and interest payments are long due. They are also called ‘distressed assets’ or ‘bad assets’.

For a bank, a loan is an asset as it generates income from the interest payments. However, it classifies the loan as a non-performing asset when the borrower fails to repay the loan despite repeated attempts by the bank. Typically, an asset is classified as an NPA after 90 days.

An NPA is never desirable for a bank or lending institution as it puts considerable pressure on their financial health. Nevertheless, they make provisions for these assets that have gone bad.

Non Performing Assets in India

The problem of NPAs in India is quite grim, but improving. As per official sources, as of March 31, 2023, 1.96 lakh crore NPAs are outstanding. Nevertheless, there is also an expected improvement in banks' asset quality by FY2023-24. The bad loans of banks are projected to drop to 4.5% by the stated year.

Also, as per a recent press release by the Press Information Bureau, the Government of India’s Department of Financial Services (DFS) has reported a significant reduction in the NPAs of Scheduled Commercial Banks. The NPAs have decreased from Rs 9,33,779 crore as of March 2019 to Rs 5,71,515 crore as of March 2023. This decline can be attributed to initiatives such as Insolvency and Bankruptcy Code, amendments to the SARFAESI Act, and the Prudential Framework for Resolution of Stressed Assets.

There is also a notable improvement in asset quality as the Net NPAs of SCBs reported a decline of Rs 1.36 lakh crore in March ‘23 from Rs 2.04 lakh crore in March ‘22.

What is an Asset and Non-performing Asset for a Bank?

In the context of banking, loans and advances are an asset. This means, an asset is anything that has the potential to generate income or provide economic benefits in the future for the bank.

While a non-performing asset is one that has stopped generating income. The principal and interest payments on these loans are outstanding even after repeated initiatives by the lender to recover the same. They are also called ‘distressed assets’ or ‘bad assets’.

Some of these NPAs are loans, bonds, credit card debt, mortgages, commercial loans, and credit card debt.

How Non-performing Assets (NPAs) Work?

For a loan to be categorised as an NPA, a considerable period of non-payment should have passed. Lenders consider all the factors that result in a delayed payment of the interest and principal payments. Even after 90 days, when the borrower has still not made the due payments, will the asset be considered an NPA.

When such a case arises, banks record the asset on their balance sheet. They then initiate the necessary course of action. If a borrower has pledged collateral and cannot pay, the bank can seize and sell the collateral and recover the dues. If the borrower has no pledged collateral, the lender can classify the asset as bad debt and sell it to the collection agency at a discounted price.

Types of Non-performing Assets (NPA)

The Reserve Bank of India (RBI) has stipulated that banks follow a standard classification of assets. The classification is as follows:

• Standard Assets: As per the RBI, Standard Assets carry only normal risks attached to the business and do not pose any problem to the lender. Hence, according to the RBI, such an asset should not be a non-performing asset.
• Sub-standard Assets: These are NPAs that have not exceeded 12 months as regards the repayment of dues. Here, the risk associated with Sub-standard assets is higher than standard assets as the banks are most likely to suffer some loss if the identified deficiencies are not rectified.
• Doubtful Assets: When an asset has been in the sub-standard category for over 12 months, it is categorised as a Doubtful asset. Doubtful assets make collection or liquidation in full highly questionable and doubtful.
• Loss Assets: Loss assets occur when the financial institution or regulatory body cannot (partially or wholly) write off a non-performing asset. Such an asset is considered uncollectible and of very little value to continue as a bankable asset, even if it has some recovery value.

NPA Provisioning

While NPAs are not favourable for the bank or a lending institution, banks set aside a portion of their profits or income to cover NPAs. This is called NPA provisioning.

To explain the concept further, NPA provisioning is when the bank anticipates the probability of default and sets aside some amount from profits for non-performing assets. This way, banks can maintain a healthy book of accounts.

Provisioning for NPAs is done by banks depending on whether they are Tier I or Tier II banks and the type of classified asset. Generally, riskier loans require higher provisioning. However, strong banks can set aside less.

GNPA and NNPA

The RBI mandates banks to make the NPA numbers public regularly. Hence, banks have the following two ways of revealing their NPA situation.

Gross Non-performing Asset: Gross non-performing assets, or GNPA, are the total value of gross non-performing assets for the bank in a particular quarter or a financial year. GNPA is the total of the principal amount and the interest on that loan.

Net Non-performing Asset: Net non-performing assets are the value of NPAs that remain after deducting the provisions made by the bank. This is the exact value of NPAs after the bank has provisioned for it.

NPA Ratios

Besides knowing the NPAs and their values, there are NPA ratios too. This helps indicate how much of the total advances are not recoverable and are warning signs of potential financial distress. There are two ways of calculating the NPA ratios.

GNPA Ratio: The GNPA ratio is the ratio of gross NPA to gross advances.

NNPA Ratio: The NNPA ratio is the ratio of net NPA to net advances.

Example of NPA

Suppose a borrower obtains a loan of Rs 10 lakh for his business.

For a straight nine months, he makes monthly repayments of Rs 10,000.

The problem starts from the 10th month. The borrower is unable to pay for the next three months.

Now, the bank classifies the borrower's loan as NPA and initiates steps to recover the same.

Loans and Credit Score

At the retail level, a customer often borrows for personal reasons or business purposes. A personal loan is an unsecured loan used for any legal purpose such as education, vacation, home improvement and other purposes. Interestingly, a personal loan can also be used to improve the credit score.

A business loan is taken to start a new business or scale an existing business. It is used to finance working capital management; ensure cash flows in periods of slowdown; invest in new technology or equipment; acquire new business; refinance existing debt and leverage new business opportunities to grow.

IIFL mandates that applicants for business loans should have a CIBIL score of 675 and above.

IIFL Finance offers the option to check one’s CIBIL score on its website. Visit https://www.iifl.com/credit-score to know one’s credit score from the credit score report.

This credit score helps lenders assess the repayment ability of the borrower.

FAQs

Q1. What are Non Performing Assets?

Non-performing assets are loans and advances by banks that have stopped generating income.

These are assets that have outstanding principal and interest payments on them for over 90 days.

Q2. How do Banks Deal With NPA?

Banks deal with NPAs by initiating follow-ups, issuing preliminary letters, approaching the guarantor to repay, offering EMI holidays, imposing a penalty on default and late payments, seizing and selling the collateral to recover the dues, and, as a last measure, initiating legal action if the borrower is a wilful defaulter.

Q3. What Happens to Non-Performing Assets?

If the borrower has pledged assets, the lender may take legal action and compel the defaulter to liquidate the pledged assets.

In the absence of collateral, prolonged non-repayment may lead the lender to classify the loan as bad debt. The lender may even sell the NPA at a discounted rate to a collection agency.

Q4. What is an Example of a Non-Performing Asset?

To give an example of an NPA, consider a home loan by a borrower. After making initial EMI payments, the borrower stops paying the principal and interest, and it remains unpaid for over 90 days. The loan then becomes an NPA.

Q5. What is the rule of NPA?

As per the Reserve Bank of India's rule, a loan with outstanding interest and principal payments for over 90 days is categorised as an NPA. It becomes a sub-standard asset if the same is unpaid for up to 12 months. If it exceeds 12 months, it becomes a doubtful asset and becomes a loss asset. The latter happens when the bank cannot partially or wholly write off an NPA. It is then considered uncollectible and of very little value to continue as a bankable asset, even if it has recovery value.