People or organisations take loans from banks and sign an agreement to repay them within time. What if the lender or the bank fails to recover these loans from its clients? As most of you must be aware, security comes into the scenario when a loan remains unpaid. Before lending an amount, bank always asks for something as security that would be seized if the borrower is unable to pay the due amount. What if the mortgaged property or the collateral property is not sufficient for the bank to recover from losses? What is the term for the loan that remains unpaid? How does the bank recuperate from such bad debts? In this article, we will be discussing Non-performing Assets that will give you the answer to all the above questions.
So, without delaying any further let’s get started…
What is an Asset?
An asset is something that anyone owns. In regard to banks, a loan is an asset as the interest that a borrower pays alongwith the loan amount is the financial earning of the bank. The interest is therefore, the payment for the banks in exchange of loans.
What are Non-Performing Assets?
When customers, retail or corporates are not able to pay back the loan amount for a certain period of time, the asset becomes non-performing assets. Since the bank is unable to collect the due amount or earn an income, the assets are referred to as NPAs. According to Reserve Bank of India, NPAs are assets that generate no income for them.
An NPA refers to those loans that are in arrears or in default. A loan amount is in arrears when interest or principal remains unpaid and a loan is in default when the borrower fails to follow the regulations of the loan agreement.
The Non-performing Assets are mentioned in the bank’s balance sheet after the loans were not paid for a longer period of time. The more duration the NPAs are listed in the balance sheet, the more the bank is at jeopardy.
When exactly is a debt declared as Non-performing?
- A debt or a loan amount is declared as a Non-performing Asset when it has not been paid for 90 days (3 months) since the loan amount was provided.
- This time period may vary as it is also dependent on factors like the terms and conditions of the loan agreement.
- The debt maybe declared as an NPA during its maturity or before that. There are also other circumstances when a debt maybe termed as non-performing.
- If a XYZ company pays all the interest but is unable to pay off the principal at maturity, his debt will be termed as a Non-performing Asset.
What is a write-off?
A write-off is reducing the amount of an asset.
What Happens When Assets Become Non-Performing?
- When assets become non-performing, banks face different problems.
- The lender’s cash flow is reduced which can hamper budgets and reduce earnings. As a result, they incur heavy losses.
- Since bank tries to cover up these losses through NPA provisioning, there is not enough capital to lend to other borrowers. Thus, there is financial burden on these banks and the performance of the banks are at stake.
- In such a scenario, banks may decide to take possession of any collateral. This means that banks will liquidate any mortgaged property or assets that were pledged as part of the agreement.
- In case there is no pledged asset or mortgaged property, banks may decide to write-off the NPAs as a bad debt against earnings and sell them off at a sizeable discount to a collection agency.
Types of Non-Performing Assets
- The most common type of NPA is a term loan.
- The other NPAs include overdraft and cash credit accounts that are left out-of-order for more than 3 months (90 days).
- Agricultural loans whose principal and interest was not paid for two crop seasons or harvest seasons for short-term crops are termed as NPAs. For long-term crops, if the overdue exceeds one crop season or harvest season, the debts will be termed Non-performing Assets.
- If the amount for any other account turns overdue after 90 days, those assets will also be termed as NPAs.
Three Categories of Non-Performing Assets
There are three categories of non-performing assets depending on their duration of acting as NPAs and the probability of repayment.
A sub-standard asset is one which has been an NPA for less than or equal to 12 months time.
A doubtful asset is one which has been an NPA for more than 12 months time.
Loss Assets are uncollectible assets or assets that cannot be considered as bankable anymore. These losses are either identified by a bank, an inspector or an auditor and needs to be fully written off. These assets may have extended time for non-payment. If the asset is not written wholly or in parts, it is because few chances of recovery may still be left.
How to Recover Losses Associated with NPA?
First and foremost, the bank will take necessary steps to avoid classifying a loan as Non-performing Asset. For that purpose, it will try to restructure the loans to maintain a consistent cash flow.
Restructuring debts is about modifying the financial and operational aspects of a company to bear minimum losses. Examples of restructuring can include cutting payroll costs or reducing the size of the company by selling off assets.
If the bank labels the assets as Non-performing, there are a few steps to follow while trying to recover the losses associated with the NPA:
- As already mentioned, mortgaged or collateral property can be sold by the bank to pay off the loans.
- Bad loans can also be converted to shareholders’ equity. Equity is the amount of money that is returned to a company’s shareholder through the liquidation of assets. By applying this step, the principal amount that was lost might be fully recovered.
- To recover from financial losses, banks may also sell the NPAs to debt collectors or collection agencies. These agencies make their best efforts and adopts different strategies to recover loan amounts.
Selling of bad debts takes place when the debt is unsecured or when other recovery methods are not cost-effective.
What is NPA Provisioning?
- Banks set aside a sizeable amount from their income or profits to pay off the losses from NPA assets. This is known as NPA provisioning. It is one way of paying off bad assets to prevent future losses. Thus, a healthy book of accounts can be maintained by the bank.
- The type of NPA provisioning depends on the categories of Non-performing Assets and the type of banks. For example, the Tier-I banks have different provisioning norms than Tier-II banks.
What is GNPA and What is NNPA?
- It is mandatory for banks to disclose the NPA metrics to RBI at regular intervals. The NPA metrics are present in the standalone financial statements of the bank.
- There are basically two metrics that give us a numerical overview of the Non-performing Assets. They are- 1. NPA in Absolute Numbers and 2. NPA Ratios.
NPA in Absolute Numbers
- Gross Non-performing Assets (GNPA): GNPA tells you the total or gross amount of the NPAs in a particular financial period. It is inclusive of provisions.
- Net Non-performing Assets (NNPA): NNPA only tell you the net amount of NPAs after deducting the provisions from it. Therefore, NNPAs is the actual amount of NPAs before provisions were introduced.
NPAs is equal to percentage of total loan advances. By calculating this, we will have an idea about the amount that is not recoverable.
- GNPA ratio = Total GNPA/ Total advances
- NNPA ratio = Total NNPA/ Total advances
India has a serious problem of Non-performing assets. Thankfully, the Indian government and the Reserve Bank of India has taken certain steps to mitigate the issue of NPAs. By identifying hidden NPAs, conducting credit assessments, staying alert of the early warning signals, bad debts can be reduced or eliminated.
What do you think are the other ways of tackling Non-performing Assets? Share with us in the comment section below.
Frequently Asked Questions (FAQs)
What is NPA as per RBI?
According to the Reserve Bank of India (RBI), NPAs are assets that stop generating income for banks.
What is NPA with examples?
NPA is referred to those assets, loans or advances that remain unpaid by a borrower to the lender or the bank for a period of 90 days.
For example, the bank gives a loan of Rs 15 crores to an airline company. After 90 days, the airline company is unable to pay the due amount, then there are high chances that the loan is likely to be categorised as a Non-performing Asset.
How are Assets Non-Performing?
Assets are called Non-performing because they are yielding or generating no income for the lender or the bank. In other words, the assets are not performing as is expected or desired.
What are the types of NPA?
The types of NPA are- Sub-standard assets, Doubtful assets and Loss Assets.
Sub-standard assets – NPA for less than or equal to 12 months.
Doubtful assets- NPA for more than 12 months
Loss Assets- Assets that are uncollectible are called loss assets.