Non-performing Assets: Meaning, Effect & Recovery

Non-performing assets have been in the news for many banks in the country. However, not only do banks have non-performing assets, businesses have them too. This article will help you understand non-performing assets, their types, their impact, and more. So, let’s start.

What is a Non-Performing Asset?

Non-performing assets can be defined as amounts that are pending from the borrowers, or debtors that they are not paying as per agreed terms. Usually, this amount includes both interest and principal payment, and even after extending tenure for repayment, if the borrowers do not repay the amounts borrowed along with the interest within the stipulated period, then it can be considered as non-performing assets (NPA).

The common causes of NPAs include economic downturns when people are hit by financial crises and they cannot repay their loans. It can be also a result of lending practices, which are not up to the mark. If a company or bank offers credit to people who are not worthy of the same, then it can lead to the formation of NPAs.

How Non-performing Assets (NPA) Work?

When borrowers and debtors fail to make payments, that they once agreed upon, the amounts are recorded as non-performing assets in the books of the company/ bank or financial institution. Now in the case of banks and financial institutions, the borrowers may have taken the loan against some assets, which are known as collateral, and the bank can sell the collateral to recover the money.

In case there is no such collateral and the company or the bank cannot recover the amount due by selling off any assets, they can sell the same to the collection agencies at a discounted price and mark it as NPA.

In the case of companies, it is more risky, as there is no collateral, and thus for the non-performing assets management, they have to write the entire amount off as NPA.

Types of Non-performing Assets (NPA)

There are different non-performing asset types which include –

• Standard Assets: These are NPAs, which are due for around 9 months to 12 months, and the risk factor is normal which means, the chances of recovering the amount are average.
• Sub-standard Assets: If the amount can’t be recovered within 12 months then it can be categorized as a sub-standard asset class of NPAs. Here the risk factor is higher than the standard assets and the borrower has less ideal credit in these cases.
• Doubtful Debts: These are NPAs where the due period is over 18 months and there is hardly any chance now that the borrower will pay the full amount due. These NPAs affect the business significantly and increase the risk factor.
• Loss Assets: Here the repayment tenure has been extended, even then, no repayments have been made, and ultimately the business has to write the entire amount off from the books and record it as a loss.

Examples of NPA

With a non-performing assets example, it will be easy to understand how NPAs work.

For instance, let's say Bank ABC has a total outstanding loan of Rs. 100 crores. Now, out of the same, Rs. 10 crore has been classified as non-performing assets. On the other hand, the bank has a provision against NPAs worth Rs. 5 crore.

Therefore, the Net NPA would be = Rs. 10 crore – Rs. 5 crore = Rs. 5 crore.

Also, you can calculate the NPA Ratio in an organization.

Gross NPA Ratio = (Gross NPA/ Total Loans Outstanding)*100 

                             = (Rs. 10 crores/Rs. 100 crores)*100 = 10%

Net NPA Ratio = (Net NPA/ Total Loans Outstanding)*100 

                             = (Rs. 5 crores/ Rs. 100) *100 = 5%

Impact of NPA on Banks, Borrowers, and the Economy

The impact of non-performing assets can be felt across the lending institution, borrowers' profile, and the entire economy. Let's discuss each in detail.

Impact on Banks/lending institutions

• The first impact is on the books of account, losses are recorded when NPAs are generated. The amount they have lent and the interest both are financial losses for the lending institute and thus recorded as losses in the books.
• To deal with these losses, lending institutions usually make provisions, however, the higher the provisions, the more pressure will be there on the liquidity quotient of the banks and lending institutions. It affects the financials of the banks as well. However, making provisions doesn't guarantee that the entire loss can be covered and that is another concern for the bank.
• Large amounts of NPAs can affect your credit rating as a bank or lending institute, which can affect your credibility, and deposits may decrease as savings or current account holders or fixed deposit holders may not feel safe depositing their money with the bank. This leads to a decrease in goodwill and reputation as well.

Impact on Borrowers

• When a person takes a loan and fails to repay, and it is recorded as NPA, the credit score of the borrower gets adversely impacted. It affects both credit history and credit score making it tough for the borrower to avail loans in the future.
• It can lead to legal consequences as the banks often sell the NPAs to collection agencies, which take legal steps to recover the amounts.
• If the loan, which has been recorded as NPA, was taken against any collateral then the asset can be seized and the lender can sell the asset to recover the money.

Impact on Economy

• When lending institutions and mainly significant public sector banks have higher amounts of NPAs, then it affects the entire economy as the lending process slows down affecting economic growth and production in a country.
• Central banks often have to barge into the matter so that public sentiments are not hurt. To do so, it has to finance the NPAs of the banks, which puts pressure on its financial standing and affects other duties of the central bank. It puts additional pressure on the budget of an economy.

Conclusion

Therefore, to conclude, NPAs are not good for borrowers, nor are they good for the lending institutes or the economy. So, if you are a lending institute make sure you do all the due diligence before processing any loan application and if you are a borrower, make sure, you repay the loan within the stipulated period to avoid any further escalations.

FAQs on Non-performing Assets or NPA:

1.What does NPA mean?

NPA means non-performing assets, which are loans or credits that borrowers availed but did not repay within the stipulated period.

2.What is the reason for NPA?

There are multiple reasons for NPA, which includes –

• Economic downturn
• Inadequate lending practices
• Poor monitoring
• Fraud

3.Who controls NPA?

RBI and the Government of India together have framed certain policies regarding NPAs that need to be followed across lending institutions.