What Is NPA in Banking: Meaning, Types, and Impact on Banks When the borrower defaults on his/her loan, the loan/credit, which was once a useful instrument, now becomes an asset acting as an obligation on the lender/bank. Such an asset is called Non-Performing Assets (NPAs). Commonly referred to as "Bad Loans," NPAs are a significant challenge to the Indian banking system, quite often captured by the media for the impact on the economy in the country.
What is NPA in Banking? NPA: It is a loan/advance where the interest/payment of the principal has been overdue for some time. In most cases, the time duration is 90 days. In order to know what is a Non-Performing Asset, it is first necessary to know what is an Asset for the Bank. When you put your money into a bank, this becomes a liability for this institution, as this is a promise for which they will have to pay you sometime in the future. When a bank provides a loan to someone, this becomes an asset for the bank, you might want to know why, and this is because it will generate money for the bank, i.e., interest. When the borrower makes the payment of EMI (Principal + Interest) on time, the asset is considered as “performing.” The very moment when the payment is not made, it is considered as a non-performing asset (NPA) .
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When Does a Loan Become an NPA? Banks do not declare a loan bad the very next day you miss a payment. There is a grace period.
Accordingly, with RBI guidelines, an asset is classified as Non-Performing Asset when:
Term Loans: Interest or installments are overdue beyond 90 days.Overdraft/Cash Credit (OD/CC): The account will remain ‘out of order’ for more than 90 days.Agricultural Loans: For short-duration crops: Overdue for two crop seasons.For long duration crops : Overdue for one crop season.Think of it like a school disciplinary record: missing a day of school equals an "absence" or being "overdue," while missing 90 consecutive days earns you the title "NPA ."
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The Different Types of NPA Not all NPAs are created equal, however, as the longer the money has been "missing," the longer the bank holding the account considers the transaction to be "bad."
They categorize all NPAs into three groups based on the length of time the money has been unaccounted for, enabling the RBI to gauge the likelihood of repayment for the bank.
1. Substandard Assets If the loan has remained non-performing for a time period of less than or equal to 12 months, then such a loan is called a Substandard Asset. There still remains a hope that the borrower will pay up, but the bank starts to feel the risk.
2. Doubtful Asset But if the loan remains a 'Substandard' asset for over 12 months, the loan is subsequently 'promoted' to the grade of Doubtful Asset. Here, the bank is wondering if they are ever going to see this money again.
3. Loss Assets These are the worst of the lot. A Loss Asset is an asset that has been identified by the bank, internal/external auditors, and RBI as not collectible. The money has gone, and all that this asset will do for the bank is take up space.
Gross NPA vs. Net NPA If you go through the results announced by banks for their respective quarters, you are definitely going to find the words ‘Gross NPA' and ‘Net NPA’ . However, before you get a headache thinking about the difference between these two words, listen to this:
Gross NPA (GNPA): This is the total amount of loans that have actually defaulted. This is the 'raw' amount of bad luck. Assuming we have 10 people out of whom 10 have defaulted loans amounting to 1 Crore, this will be 10 Crore in Gross NPA.
Net NPA (NNPA): Banks are wise institutions, and they keep their money aside at all times to avoid losing it. This is called provisioning.
Formula: Net NPA = Gross NPA - Provisions
The Impact of NPA on Banks and the Economy NPAs aren’t just a problem faced by banks, but they actually affect you and me. Let’s see how:
1. Profitability Hits the Floor Banks make money through interest earnings. Once their loans become NPAs, they do not earn anything from them. In addition to this, they have to make provisions (i.e., their own profits) to pay off their bad loans. In other words, they suffer huge losses.
2. High Interest Rates for Us In order to earn back the money lost on NPAs, banks may raise the rates of interest on other loans. Hence, honest people are made to suffer for the mistakes made by defaulters.
3. Lower Credit Growth If a bank is heavily loaded with NPAs, it becomes "scared" to lend. If banks don't lend, new businesses will not be formed, and the economy will not grow.
4. Shareholder Confidence For instance, if you have invested in a bank that had high NPAs, then the investment value goes down, as this indicates poor management.
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How Banks Recover NPAs Banks don’t just sit and cry over the loss of money; they have mechanisms. They have a toolkit that helps in the recovery process.
SARFAESI Act (2002): This is a very powerful act, which gives powers to the bank to auction the assets of the loanee, e.g., the house or factory of the individual, without any court jurisdiction.Insolvency and Bankruptcy Code (IBC): Essentially a modern mechanism to fix a company or sell it off fast to repay debts.Debt Recovery Tribunals (DRT): Special courts for the recovery of bank dues only.Bad Banks (NARCL): This is a new concept in which a "Bad Bank" will buy the NPAs from regular banks, allowing the banks to return to normal business.Conclusion NPA in banking has to be understood, as it’s ultimately a pulse check for an economy. A high NPA indicates that the economic system is choked, and vice versa. For the banks, being effective at NPA management is about being sufficiently helpful to lend to those in need, while being equally strict enough to get the money back. As a student or just being a citizen, being able to understand what an NPA is helps one comprehend why banks are the way they are, and why the government is so keen on ensuring that the banks' balance sheets are clean.
FAQs 1. Is an NPA the same as a Bad Loan? Yes, in everyday speech it is the same. In banking technicalities, we use the word "Non-Performing Asset."
2. Does an NPA ever revert to being a normal loan again? Yes, The loan can be upgraded to "Standard Asset" upon paying all overdue principals and interests.
3. Does a High Level of NPA Indicate Bank Closure? Not necessarily, since a lot of Indian banks have been able to tide over the periods of high NPAs since "Recapitalization"-where the Government infuses fresh money into the banks-in case of Public Sector Banks, is borne by the Government.
4. If I missed one EMI due to some medical emergency, am I an NPA? No, you have to default on your payments for 90 consecutive days to become an NPA. Your account may become "Overdue" or "Stressed," but you are certainly not an NPA, and you’ll still have to pay the late payment charges and your loan is still "Standard."
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