What Is Non-Performing Asset (NPA): Types of NPA, Its Impact and More
What Is Non-Performing Asset (NPAs)?
A non-performing asset (NPA) is a loan or advance in default or in arrears as the principal or interest payment is overdue for 90 days.
The RBI, in a 2007 circular said, “An asset becomes non-performing when it ceases to generate income for the bank.”
Traditionally, any valuable resource that can be sold and converted into cash are called assets. They either generate revenue or benefit individuals, companies and governments in some other way. But for banks, any financial instruments that belong to them or anything that’s owned by the borrower is classified as an asset.
For example, a loan will be considered as an asset because borrowers pay interest to the banks. When a borrower defaults a loan or fails to repay the money the asset becomes non performing for the lender or banks. Because it fails to generate any income.
Non Performing Assets: Definition given by RBI
According to the Reserve Bank of India (RBI), an asset (including a leased asset) becomes non-performing when it ceases to generate income for the bank. Any loan or advance that is overdue for more than 90 days will be defined as NPA. This means that any loans or advances that are in default or in arrears will fall under non-performing assets (NPA).
NPA was defined as a credit facility in respect of which the interest and/ or instalment of principal has remained ‘past due’ for a specified period of time. So any due amount owed to the lender is treated as “past due” when it’s not cleared within 30 days.
For example, if a debtor fails to meet his/her obligations to pay the loan the lender considers the agreement void and considers the asset as non-performing. But on March 31, 2001 the RBI decided to dispense with the ‘Past Due’ concept.
As from that day, NPA shall be an advance where:
- Interest and/or instalment of principal remain overdue for a period of more than 180 days in respect of a term loan
- The account remains ‘out of order’ for a period of more than 180 days, in respect of an Overdraft/Cash Credit
- The bill remains overdue for a period of more than 180 days in the case of bills purchased and discounted
- Interest and/or instalment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purposes
- Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts
To ensure transparency and international best practices the RBI has decided to embrace the 90 days overdue norm. In this scenario, NPA shall be a loan or advance where:
- The interest and/ or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan
- The account remains ‘out of order’ for a period of more than 90 days, in respect of an Overdraft/Cash Credit
- The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted
- The interest and/or instalment of principal remains overdue for two harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purposes
- Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts
Source: RBI
Classifications for Non-Performing Assets (NPAs)
The below table gives the different classification of non-performing assets:
| Classifications for Non-Performing Assets | Criteria |
| Substandard assets | These assets have remained NPA for a period less than or equal to 12 months. |
| Doubtful assets | These are assets that have remained in the substandard category for a period of 12 months or more. |
| Loss assets | These assets are considered uncollectible and of very little value. Although these assets could have some recovery value, they cannot continue as a bankable asset. |
How Non-Performing Assets (NPA) Work?
After a prolonged period of default, the lender forces the borrower to liquidate the assets that were pledged as collateral in the debt agreement. If assets were not pledged, then the lender writes it off as bad debt and sells it to a collection agency at a discount. A loan can be classified as a non-performing asset at any point during the term of the loan or at its maturity.
An example: Let’s assume that a company took a loan of ₹ 20 million. If the company fails to pay the interest ₹100,000 per month for three consecutive months, the lender categorises this loan as non-performing asset, listing it as an NPA on its balance sheet. A loan can also be categorised as non-performing if a company makes all interest payments but fails to pay off the principal at maturity.
What are the types of Non-performing Assets?
Term loans are the most commonly known non-performing assets. Here are some other examples:
- Overdraft and cash credit left out of order for more than 90 days
- Agricultural advances whose interest or principal installment payments remain overdue
- Expected payment that’s overdue for more than 90 days on any type of account
- And ofcourse, term loans
What’s the difference between Non-performing Asset (NPA) and Non-performing loan (NPL)?
| NPA | NPL |
| NPAs are documented on a bank’s balance sheet after the borrower fails to clear the dues for a prolonged period | The borrower has defaulted and hasn’t cleared any dues or installments for some time |
| NPAs place financial burden on the lender | In the banking sector, loans are declared non performing if the borrower has missed payments for 90 days |
| NPAs also showcase the financial wellbeing of a bank | The International Monetary Fund (IMF) will consider loans as non performing if the chances of recovering money is uncertain and are less than 90 days past due |
| The classification of NPAs depends on the repayment length | NPLs are also sold by banks to other banks, and maybe, investors |
| NPAs can be classified as substandard, doubtful and loss asset | |
| Lenders can recover their losses by taking possession of any assets that belongs to the borrower |
Why Do Banks Worry About an Account Turning Into an NPA?
There are numerous reasons why banks worry about their accounts turning into NPAs, but we’ll discuss the major ones:
- Revenue Loss: When an account turns into an NPA, it become a stressed account, and banks have to stop charging interest on it.
- Brand Image: A higher number of NPAs reflects badly on the image of the bank.
- Higher Provisions: The RBI imposes a certain set of rules on the banks to make provisions at a higher rate if an account turns into NPA.
- RBI Action: In some cases, the RBI may take harsh actions.
- Stock Market Crash: The bank’s stock market prices may fall if it’s listed with NPAs.
What Are the Impacts of Non-Performing Assets (NPA)?
When accounts turn into NPAs, the impact is as follows:
- Banks do not have sufficient funds for other development projects, thus impacting the economy.
- The curb in further investments may lead to the rise of unemployment.
- Banks are forced to increase interest rates to maintain a profit margin.
Impact of NPA on Borrowers
- CIBIL Score: The NPA impacts the borrower’s creditworthiness, thus hurting their CIBIL score.
- Brand Image: An NPA impacts the goodwill of the borrower.
- Future Funding Issues: Banks will be apprehensive about sanctioning a loan to a borrower whose account is an NPA.
- Impact on other Group Entities: An NPA doesn’t only impact the borrower but also the other group entities.
How to Calculate Gross NPA ratio and Net NPA?
The Gross NPA is the amount obtained on adding the principal amount and the interest over that principal amount on it.
Gross NPA = (Amount1 + Amount2 + ….. + Amount N)⁄Gross Advances
where, Amount 1 to Amount( n) is the amount loaned to persons 1 to n.
Gross Advances is the outstanding loan amount
Net NPA= (Gross NPA – Provisions)⁄Gross Advances
Where ‘Provisions’ is the amount kept reserved by the bank or financial institution in advance for bad loans or any loss that might happen due to non-repayment of those loans.
NPAs are not favourable for banks as they are non-performing. A high number of NPAs means that too many loans have become non-functional or are not generating any interest income for the bank. However, the banks have the choice to either keep the NPAs in their books, hoping that they will recover or make provisions for them. Or, they can write it off entirely as a bad debt. NPAs in India have grown in the last few years and are impacting the economy. Therefore, it is the need of the hour for government and banks to improve their practices to arrest the growth of NPAs.
