Assets that create revenue are known as performing assets, while those that do not generate revenue are known as non-performing assets. A financial obligation in which the borrower has failed to pay the designated lender any previously agreed-upon interest and principal repayments for a lengthy period of time. As a result, the lender receives no income in the form of principal and interest payments from the nonperforming asset. A non-performing loan, for example, has gone into default. The lender will force the borrower to sell any assets pledged as part of the loan agreement after an extended period of non-payment. If no assets were pledged, the lenders might write off the asset as a bad debt and then sell it to a collection agency at a discount. When an asset stops generating income for the bank, it is classified as non-performing. A nonperforming asset (NPA) is defined as a credit facility for which interest and/or principal installments have been “past due” for two quarters or more. When an amount due under a credit facility is not paid within 30 days of the due date, it is considered “past due.” However, it was agreed to forego the payment of past dues.
Types of NPA’s
NPAs come in a variety of shapes and sizes.
NPAs must be classified as Substandard, Doubtful, or Loss assets by banks.
Substandard assets are those that have been nonperforming for less than or equal to 12 months.
Questionable assets: An asset is considered doubtful if it has been in the subpar category for more than a year.
“Loss asset is regarded uncollectible and of such low value that its continued status as a bankable asset is not warranted,” according to the RBI, “although there may be some salvage or recovery value.”
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Reasons for increasing NPA
Governance Issues Companies divert funds for uses different than those for which loans were obtained. Initial loan disbursement did not include due diligence. The concern is inefficiencies in post-disbursement monitoring. Banks had already restructured loans to avoid provisioning. Following the RBI’s crackdown, banks have been obliged to clear their asset books, resulting in a surge in nonperforming assets (NPAs). During the economic boom, banks took corporate optimism at face value and did not conduct necessary background checks before approving loans. Double leveraging by corporations in the absence of proper governance mechanisms, as highlighted by the RBI’s Financial Stability Report.
Economic Reasons The economic crisis that began in 2008 has contributed to an increase in problematic loans. Because global demand is low, exports across all sectors have been on a long-term downward trend. The bad financial status of most SEBs is an issue in industries like energy; in areas like steel, the collapse in world pricing means that many more loans will be stressed in the months ahead. One of the reasons for the rise in bad loans, according to the Economic Survey 2015, is corporate leverage. Another aspect that may contribute to the low level of expertise in many large public sector banks is the regular turnover of jobs among officers, as well as the loan officers’ apparent lack of training in lending principles. Insufficient loan recovery and the use of coercive measures by banks.
Political Reasons Several PPP projects were hampered by policy paralysis under the previous administration, and crucial economic decisions were postponed, affecting macroeconomic stability and resulting in lower corporate performance. Crony capitalism is also to blame. Banks are obligated to offer loans for particular sectors that are most stressed due to political pressure.
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Impact of NPA on the economy
The problem of nonperforming assets (NPAs) in the Indian banking sector is one of the most serious and pervasive issues that has impacted the entire banking industry. Investors, depositors, and lenders lose confidence when the NPA ratio rises. It also results in inefficient money recycling, which harms credit deployment. Non-recovery of loans has an impact on not just the availability of credit but also the banks’ financial stability.
Profitability: NPAs harm profitability since, on the one hand, banks stop earning money and, on the other hand, they draw higher provisioning relative to regular assets. On average, banks provide a 25 percent to 30 percent higher provision on incremental NPAs, which has a direct impact on the banks’ profitability.
Credit (asset) contraction: Increased nonperforming assets put pressure on fund recycling, limiting banks’ ability to lend more, resulting in lower interest revenue. It reduces the money supply, potentially slowing the economy.
Liability Management: In the face of significant NPAs, banks tend to cut deposit interest rates while levying higher interest rates on advances to maintain NIM. This could create a roadblock in the smooth financial intermediation process, hampered bank business and economic progress.
Capital Adequacy: Banks are expected to maintain appropriate capital on risk-weighted assets continuously, according to Basel standards. Every growth in nonperforming assets raises risk-weighted assets, requiring banks to shore up their capital base even more. Because capital is a finite resource, it has a price tag ranging from 12% to 18%.
Shareholder confidence: Shareholders are frequently interested in boosting the value of their assets by increasing dividends and market capitalization, which can only be accomplished if the bank makes significant profits through improved operations. Increased NPA levels are likely to have a detrimental impact on bank business and profitability, resulting in shareholders not receiving a market return on their capital and, in some situations, seeing their assets depreciate. Current regulations require banks with a Net NPA rating of 5% or greater to obtain RBI approval before declaring dividends, with a dividend payout cap.
Public confidence: The credibility of the banking system is also affected greatly due to higher-level NPAs because it
shakes the confidence of the general public in the soundness of the banking system. The increased NPAs may pose
liquidity issues which are likely to lead to run on banks by depositors. Thus, the increased incidence of NPAs not only affects the performance of the banks but also affects the economy as a whole. In a nutshell, the high incidence of NPA has a cascading impact on all important financial ratios of the banks viz., Net Interest Margin, Return on Assets, Profitability, Dividend Payout, Provision coverage ratio, Credit contraction, etc., which may likely to erode the value of all stakeholders including Shareholders, Depositors, Borrowers, Employees and public at large. In a nutshell, the high incidence of nonperforming assets (NPAs) has a cascading effect on all important financial ratios of banks, such as Net Interest Margin, Return on Assets, Profitability, Dividend Payout, Provision coverage ratio, Credit contraction, and so on, eroding the value of all stakeholders, including shareholders, depositors, borrowers, employees, and the general public.
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