Non-Performing Assets (NPA): Definition, Types & Example

In the banking industry, non-performing assets (NPA) refer to loans on which the principal and interest payments are long overdue. This means that the banks have not received regular payments for those assets. These are called bad or distressed assets, as they do not generate expected returns. In the case of loans, when the borrowers fail to pay interest payments and default on the loan, the banks take measures to collect the interest. However, the loan is declared as NPA after 90 days if they cannot recover payment. 

What is Non-Performing Assets?

Non-performing assets are financial assets that fail to generate income for the lender due to loan defaulting or delinquency. These troubled assets could be bonds, loans, mortgages, credit card debt, etc. As per the Reserve Bank of India (RBI), when any advance or loan becomes overdue for 90 days, it becomes NPA. 

NPAs on the balance sheet are not a good sign for any financial institution. It has a negative impact on its financial condition. Banks cannot meet the stringent regulatory requirements of RBI with NPAs on the balance sheet. 

To reduce NPAs on the balance sheet, lenders take borrowers to court to liquidate the borrower's pledged assets. The lender writes it off as bad debt if no such assets are available. They can then sell these NPAs at a discounted rate to a collection agency to remove NPAs from its balance sheet. 

In India, the uptick in economic activities, restructuring of stressed units, and robust recovery network have helped banks lower their NPAs by 77% in the last six months. This is a positive sign that strengthens financial institutions. 

Types of Non-Performing Assets

The RBI has issued guidelines on the banks' classification of NPAs. The following are the different types of NPAs:

• Standard Assets – These carry normal business risks and are not problematic to the lender. Assets that have been overdue for 90 to 120 days are standard assets. 
• Sub-Standard Assets – These carry slightly higher risks than standard assets. Financial institutions are more likely to suffer a loss if they don't rectify deficiencies with this type of asset. Typically, these are overdue for about 12 months. 
• Doubtful Assets – The banks' chances of recovering these assets are very low if the assets have been overdue for at least 18 months. Such doubts will almost always result in a loss for the banks as the liquidation is highly doubtful. 
• Loss Assets – When financial institutions cannot wholly or partially write off as a non-performing asset, then it is a loss asset. It is declared uncollectible and does not have value as a bankable asset. However, it may still have residual recovery value. 

Significance of Non-Performing Assets

Dealing with NPAs is challenging for the banks due to the following reasons:

• NPAs result in financial losses for the bank, indicating potential failure to recover principal and interest. 
• With higher NPAs, banks have to set aside larger provisions. 
• NPAs lock up a bank's funds and affect its liquidity. 
• Higher NPAs raise red flags for lenders and its credit rating may be downgraded. 

NPAs also pose the following challenges for borrowers:

• The credit score and creditworthiness of borrowers whose loans have been converted into NPAs will be adversely affected. 
• Banks initiate legal proceedings to recover NPAs, which can affect the borrower's other assets. 
• Borrowers with NPAs will not be able to find additional financing easily. 

NPA Provisioning 

Financial institutions lend money to borrowers after careful consideration. However, despite all measures to recover the loans, NPAs are unavoidable. Every bank or lending institution declares a portion of its income or profits to cover NPAs. This process is called NPA provisioning, meaning the bank expects default probability matching NPA provisioning. It allows banks to maintain a healthy balance sheet. 

NPA Parameters - GNPA and NNPA & NPA Ratios

Banks are at discretion for NPA provisioning based on Tier I or Tier II banks and type of asset classification. Stronger banks can set aside less, but riskier loans demand higher provisioning. 

Customers can know about the bank's performance based on its balance sheet. RBI has mandated that banks make NPA numbers publicly available. Two key metrics show the NPA situation of the bank:

1. Gross Non-Performing Asset (GNPA):  GNPA refers to the total value of the gross non-performing assets for the quarter or financial year. It is the grand total of principal and interest amounts on the NPA loans. 
2. Net Non-Performing Asset (NNPA): NPNA is obtained by subtracting NPA provisioning from GNPA. This refers to the potential loss for the bank due to the NPAs. When banks set aside higher NPA provisioning, their NPNA will be lower. 

The NPA ratio is another metric that is crucial for the bank's NPA assets. It shows the bank's unrecoverable total advances. The NPA ratio is calculated in two ways:

1. GNPA Ratio – Ratio of gross NPA to gross advances
2. NNPA Ratio – Ratio of net NPA to net advances

Conclusion 

Non-Performing Assets (NPAs) are loans for which principal and interest payment is overdue. It affects the bank's healthy balance sheet. It also impacts borrowers as outstanding NPAs will result in poor credit history. NPAs also affect the economy because they result in a credit crunch. When banks suffer from capital shortages, it can dilute equity or force governments to assist. Higher NPAs burden the government, financial institutions, and borrowers.