What is Non-Performing Asset? Meaning, Types, Impact of NPA

B) When no assets are available, prolonged non-payment may lead the lender to classify the loan as bad debt. Additionally, the lender might transfer the NPA account to a collection agency at a discounted rate. Now, to get the NPA percentage, divide the non-performing assets by total loans to get the NPA ratio in decimal form. For the purpose of this ratio, net profit is the net income or net profit of the entity as exhibited by its income statement or profit and loss account. The denominator used is, however, the net sales which is typically the entity’s primary source of revenue.

• These assets are regarded as ‘uncollectible,’ as they have very little or no monetary value.
• In India, the RBI guidelines define an asset as an NPA if the borrower has not paid interest or principal for 90 days or more.
• Stress in the NBFC sector has been assessed to be higher under a high-risk stress scenario relative to the March 2023 position.
• When the ratio of NPAs in a bank’s loan portfolio rises, its income and profitability fall, its capacity to lend falls, and the possibility of loan defaults and write-offs rise.
• However, it is advisable that banks and other lenders may conduct thorough credit risk assessments and due diligence before making loans.

Banks will be suspicious in sanctioning loans to a borrower whose accounts are already under NPA. Due to higher NPA rates, banks will suffer significant revenue losses that will potentially affect their brand image. NPA undermines banks’ soundness and creates fear among the public to conduct any business with the bank as its liquidity is at risk. 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.

Impact of NPA on Economy

Borrowers can avoid becoming an NPA by making timely payments on their loans, maintaining a good credit score, and communicating with their lenders in case of financial difficulties. Banks are required to adhere to these norms and maintain adequate provisions to cover potential losses on their non-performing loans. Gross NPA refers to the total amount of loans and advances that are classified as non-performing assets, without taking into account any provisions or write-offs made by the bank.

Every industry, individual, government, or bank earns profit differently. Like an industry manufactures a finished product from the raw material sells it and earns a profit. But the banks don’t produce any material, they earn profits from the interest paid by the borrowers on the loan. Thus the loan amount and interest paid by the borrowers on that loan act as an asset for the banks. The banks provide every borrower with a payback period on or before which the borrower has to pay back the principal amount along with the interests to the bank. But, when the borrower is unable to pay back the principal amount and interest then it becomes a Non-Performing Asset (NPA) for the Bank.

The use of net profit ratio in conjunction with assets turnover ratio helps in ascertaining how profitably the management has managed and used the entity’s resources during the period concerned. Net profit (NP) ratio can be a useful tool for measuring the overall profitability and operating performance of a commercial entity. A high ratio number indicates an efficient management of operational affairs of the entity and a low number might indicate otherwise. Macro stress tests are performed to assess the resilience of banks’ balance sheets to unforeseen shocks emanating from the macroeconomic environment. However, if the cultivation is not as expected, the farmers fail to repay the loan. Samantha borrows a sum of $1,000,000 from the National Corporation Bank to purchase a house.

Impact of NPAs and Current Situation and Future Prediction for India:

Not only is the type of asset different, but the provisioning also varies from bank to bank. Non-Performing Assets (NPAs) are a major concern for the banking system and the economy as a whole. NPAs can impact the profitability, financial stability, and credit flow of banks, while also discouraging investment, increasing the cost of credit, and eroding public confidence in the banking system. Banks can manage NPAs by implementing effective credit monitoring and recovery systems, restructuring loans, selling bad loans to asset reconstruction companies, and taking legal action against defaulters. Gross Non-Performing Assets (Gross NPA) represent the total value of loans in a bank’s portfolio that have been classified as non-performing.

Challenges faced by Banks due to NPAs

Another problem with net profit ratio is that it is not a long-term measurement of profitability. It is mostly calculated by using the numbers from a short-period (typically one year or less) operating result of the entity and, therefore. Does not indicate anything about it’s ability to maintain operational performance on continuous basis. Moreover, an entity can temporarily improve its net profit ratio by delaying such expenditures which don’t have a significant immediate impact on profitability. For example, the management can intentionally postpone a periodic maintenance or similar other discretionary expenses to gain a higher profit number in current period and make the ratio temporarily look better. First, The government needs to recognise how its decisions independent of the banking sector can adversely impact NPAs in certain sectors and address the impact of those decisions to check the crisis.

For example, if a company borrows a sum of INR 10 crores from a bank and fails to pay the monthly interest of INR 10 lacs for 3 consecutive months then the banks categorize such accounts under NPA. Also if the company pays the whole interest amount but fails to pay the principal amount at the end then that case also comes under NPA. As loans and advances turn sour, banks and financial institutions may face the challenge of managing these nonperforming assets. Provisions help cover potential losses from assets that are non-performing.

Non Performing Assets (NPAs)

Not only the type of asset but provisioning also depends on the type of bank. Like, Tier-I banks and Tier-II banks have different provisioning norms. When customers, retail or corporates, are not able to pay the interest, the asset becomes ‘non-performing’ for the bank because it is not earning anything for the bank. Therefore, RBI has defined NPAs as assets that stop generating income for them.

An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank. A ‘non-performing asset’ (NPA) was defined as a credit facility in respect of which the interest and/ or installment of principal has remained ‘past due’ for a specified period of time. Banks/NBFCs are required to set aside a portion of their income as a provision for the loan assets so as to be prepared for any contingent losses that may arise in the event of non-recovery of loans. The amount of provision to be kept by the banks, depend on the probability of loan recovery.

A) Interest and/or installment of principal remain overdue for a period of more than 90 days in respect of a term loan. B) The account remains ‘out of order’ in respect of an overdraft/cash credit (OD/CC). C) The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted. D) Interest and/or installment of principal remain overdue for two crop seasons for short duration crops. E) Interest and/or installment of principal remain overdue for one crop season for long duration crops. Gross NPA may not accurately reflect the bank’s actual financial loss, while Net NPA provides a clearer picture of the potential losses faced by the bank.

While on the other hand if the loan amount is unpaid for more than 1 year from the due date then it is called a doubtful debt, and if it’s unpaid for more than 3 years then loss of an asset or default account. These circumstances can arise when the borrower intentionally tries not to repay the loan or has gone into huge debt. When an institution’s NPA https://personal-accounting.org/npa-ratio-definition/ is higher than the average market rate, it can increase the chances of default and institution’sratings from rating agencies. It can cause investors to sell stocks and lose confidence in the institution. The banks may also have difficulty providing new loans due to unsettled old loans, which can reduce their profitability and capital sufficiency.