BAJAJ BROKING
February 10, 2025
7 mins read
It is extremely important for a bank that the loans it provides to borrowers perform. In other words, such loans should help a bank earn interest. Read more..Besides, they should also be paid back in time. However, when a borrower does not pay interest or principal due on a loan for more than 90 days, it is classified as a non-performing asset (NPA). For banks to be sustainable and profitable, it is important to keep NPAs low. Rising NPA levels can erode a bank’s profitability and can even badly affect its reputation. Read less
Non-performing assets (NPA) are those loans that stop performing for a lender, which could be a bank or any other financial institution. In simple words, an NPA is a loan whose borrower is unable to pay its interest or principal within a stipulated time period. Hence, for its lender, such a loan does not provide the income that it was supposed to. Besides, in the worst case, a lender may even have to completely write off an NPA from its books, thereby incurring a loss. Hence, it is extremely important for financial institutions to control their NPAs.
A non-performing asset (NPA) is an advance or a loan on which the interest or the principal has remained overdue for more than 90 days. Suppose a borrower called “X” took a loan from a bank. However, when it came to paying interest or principal due on the loan, X could not make the payment even after more than 90 days from the due date, then the loan will be treated as an NPA by the bank.
A bank or a financial institution provides loans to earn interest. If the loans provided are not paid back, such assets stop performing. Hence, they are known as “non-performing assets” or “NPA.”
A bank’s asset is something that it owns, which generates an income. For example, when a bank provides a loan to a borrower, it earns an interest on it. Hence, the loan becomes the bank’s asset.
Apart from that, banks also have non-financial assets, like a building or land. In the context of a bank, the term non-performing asset (NPA) is used for a loan whose interest or principal is overdue for more than 90 days. As the interest/principal is overdue, the loan does not generate an income for the bank; therefore, it is called “non-performing.”
As per the Reserve Bank of India (RBI), a financial institution has to classify a loan as an NPA if the borrower does not pay the interest or principal due on it for more than 90 days. There is absolutely no ambiguity about it. Such loans have to be automatically classified as an NPA by a bank or a financial institution.
NPAs badly impact banks in many ways. First, non-payment of interest/principal affects a bank’s profitability and balance sheet. Second, a bank’s lending capacity is badly affected if a significant amount of funds are locked up in NPAs.
There are three types of NPAs, as explained below:
Sub-standard assets: When a loan remains an NPA for up to 12 months, it is classified as a sub-standard asset. Such loans have a much higher credit risk than other loans; however, they still have some possibility of recovery.
Doubtful assets: If a loan remains an NPA for more than 12 months, it is classified as a doubtful asset. Such loans have a much higher credit risk than sub-standard assets. Moreover, their possibility of recovery is also low.
Loss assets: When a loan has no prospects of recovery or very little recovery value, it is classified as a loss asset. Banks have to write-off the total value of such assets, thereby incurring a loss. Or, they can also sell loss assets to asset reconstruction companies (ARCs).
NPA provisioning refers to a certain amount that banks and other financial institutions keep aside from their profits to deal with any loans that “may” turn out to be NPAs.
The important word here is “may.” It means that financial institutions are not 100% sure while making a provision for a loan whether it will turn out to be bad or not. However, they still make a provision to be on the safer side.
The RBI stipulates provisioning norms in India and ensures that banks comply with the norms. The amount of provisioning depends upon the category to which an NPA belongs: sub-standard assets, doubtful assets, or loss assets.
It is mandatory for banks to report their NPA numbers in their financial statements. This ensures transparency, as vital information about a bank’s asset quality is provided to stakeholders through its NPA data. Banks report two kinds of NPAs: Gross Non-Performing Assets (GNPA) and Net Non-Performing Assets (NNPA).
a) Gross Non-Performing Assets (GNPA): This number tells us about the total amount of NPAs of a bank for a quarter/year/any other financial period before provisioning is made.
b) Net Non-Performing Assets (NNPA): NNPA tells us about a financial institution’s NPAs after it has made provision for bad loans.
Two kinds of NPA ratios are extremely important to analyse a financial institution’s health: Gross NPA Ratio (GNPAR) and Net NPA Ratio (NNPAR). Later in this blog, we will understand how to calculate these ratios.
Let us say that a person borrows ₹ 2 lakh from a financial institution. Further, assume that he has to repay the loan in 2 years with 8% per annum interest on the principal. Moreover, as per the terms of the agreement, the loan is repayable in 24 equated monthly instalment (EMI).
But, the borrower is unable to pay the very first EMI. Even after more than 90 days of the EMI falling due, he is not able to pay. Hence, the institution will have to classify the entire amount of ₹ 2 lakh as an NPA.
To calculate the gross NPA ratio, we need to divide a bank’s gross NPAs with its gross advances (before provisions) and multiply the result by 100.
On the other hand, the net NPA ratio is calculated by dividing a bank’s net NPAs with its net advances (after accounting for provisions) and multiplying the result by 100.
NPAs are important for financial institutions, investors, and regulators. It is extremely important for a bank to keep its NPAs low to remain sustainable and profitable in the short and long run.
Meanwhile, investors need to monitor the NPA levels of banks to analyse their financial well-being. Banks disclose their NPA data in quarterly and annual reports. Whether you are a retail or an institutional investor, you must thoroughly analyse how a bank is performing when it comes to its gross and net NPAs.
Regulators need to keep an eye on the level of NPAs both at an institutional and an overall level to ensure the financial system’s stability. For example, regulators need to ensure that banks make sufficient provisions for NPAs. Otherwise, banks may collapse, thereby threatening the entire financial system.
NPAs can affect a bank’s or a financial institution’s operations negatively in the ways explained below:
Limit capacity to lend: Rising NPA levels can make a bank extremely cautious in its approach to lending for the fear that more lending can result in even higher bad assets.
Corrode investors' trust: If a bank’s NPA levels remain elevated for a long time, it can badly affect investors' trust in the bank. As a result, both retail and institutional investors can start selling its stock.
Penalties and regulatory intervention: Banks and financial institutions have to strictly adhere to regulatory norms when it comes to NPAs. Failure to do so may attract penalties and other interventions by regulators, which can also affect the reputation of such institutions.
A financial institution’s gross and net NPAs are some of the most important metrics for all kinds of stakeholders. So, if you are about to open a demat account and are keen on the financial sector, you must learn the concept of NPAs thoroughly because it will go a long way in helping you make the right decisions when it comes to buying or selling a financial stock.
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Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.
This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.
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Banks set aside an amount from their income to provide for NPAs. They even try to recover NPAs. At times, they also sell loss assets to ARCs. In the worst case, they have to write-off the total value of NPAs.
When a loan is categorised as an NPA, banks try to recover it. However, if they fail to do so, they have to write such loans off from their books, which makes them incur losses.
Loans are classified as NPAs based on their repayment status. If the interest or principal of a loan remains overdue for more than 90 days, it will be classified as an NPA.
Loans that are not classified as NPAs and are performing and fully secured are known as standard assets. In simple words, their borrowers pay interest and principal due on time.
There are three types of non-performing assets: Sub-standard Assets (those loans which remain an NPA for up to 12 months), Doubtful Assets (those loans which remain an NPA for more than 12 months), and Loss Assets (loans with no recovery prospects and very little recovery value).
When a loan repayment (interest or principal) remains overdue for more than 90 days, it is classified as an NPA.
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