What is the Full Form of NPA?
The Full Form of NPA is Non-Performing Assets. It is a kind of classified assets that are used to differentiate loans and advances on which principal and/or interest is overdue, i.e., payments are in default/ arrears and generally as per set standards by regulatory authorities. The assets are considered NPA, where no recovery is made within the last 90 days.
Types
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Source: Full Form of NPA (wallstreetmojo.com)
#1 – Standard Assets
These are NPA, which remained overdue for a period of more than 90 days but less than 12 months. These assets bear the nominal risk as borrower fails to make payment regularly or on time.
#2 – Sub Standard Assets
These are NPA, which are overdue for more than 12 months, these loans have more risk, and the borrow has weak creditworthiness. What banks do is to create a haircut to such NPA as there is a risk of non-payment.
#3 – Doubtful Debts
These are Non Performing Assets, which are overdue for more than 18 months, banks having a danger of recovery, and are known as doubtful debts. Such NPA affects bank creditworthiness as more of them could put the bank at risk.
#4 – Loss Assets
This is the last classification of NPA as under these; the loan amount is classified as non-recoverable by the bank itself. The bank can either write off the whole outstanding amount or can make provision for the full amount, which will be written off in the future.
How NPA Works?
NPA are normal loans and advances, but on non-recovery after a prolonged time, usually 90 days, are categorized as NPA. After the specified period and on giving prior notice to the borrower, the lender has the right to force the borrower to sell the asset which is pledged against the loan and realize proceedings for recovery, but in case there is no asset pledged, then the lender has to write offWrite OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more/advance as bad debtsBad DebtsBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation.read more and will align it with the collection agency at a discounted rate. A loan can be classified as NPA at any point during the tenure of the loan. It is placed in the balance sheet of financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more, which marks a negative impact on its image.
Example
Justin Inc. borrowed a sum of $100M from a loan company and makes payment of $200000 monthly but due to some reasons; the company couldn’t pay the installments for three consecutive months, the lending company will be forced to classify this loan as a non-performing asset to meet the legal requirements.
Impact
The problem of NPA is alarming nowadays in our banking system. The more is the NPA. The less is the confidence of depositor, lender, or investor. It not only makes the availability of credit difficult but also disrupts the image of the institution. Following are some prominent impacts –
- Profitability – It directly affects the profit of the institution. The more is the NPA; the less is the profit as the institution must make provisions for NPA, which causes 25% – 30% more provisions leading to lower profits.
- Liability Management -To manage NPA, banks have to lower the interest rates on deposits and increase the lending rates, which in turn affects a bank’s business and economic growth.
- Asset Contraction – Increase in NPA slows down the rotation of funds, which in turn lowers the bank’s interest income.
- Capital Adequacy – Banks are required to maintain required capital on risk-weighted assetsRisk-weighted AssetsRisk-weighted asset refers to the minimum amount that a bank or any other financial institution must maintain to avoid insolvency or bankruptcy risk. The risk associated with each bank asset is analyzed individually to figure out the total capital requirement.read more as per Basil norms. The more NPA, the more capital induction is required, leading to an increase in capital cost.
- Public Confidence – NPA disrupts banks’ creditworthiness as the public is frightened to make deposits with the bank having more NPA as they have fear losing their money, as the liquidity of the bank is in endanger.
How to Reduce NPA – Indian Example
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Source: Full Form of NPA (wallstreetmojo.com)
#1 – SARFAESI Act 2002 – This act gives the power to the bank to deal with NPA without the involvement of courts. It gives the bank right to
- Asset reconstruction
- Securitization
- Enforcement of security
#2 – Debt Recovery Tribunal – In 1993 Indian Parliament Act brought DRT into existence, which empowers banks to recover loans of Rs 10 lakh and above.
#3 – Lok Adalats – Small loans up to Rs 5 lakhs can be recovered by this mechanism as per the guidelines of RBI.
#4 – Compromise Settlement – Used to settle loans up to 10 crore amounts where the borrower experiences genuine difficulties in repaying the amount under this method, the proportionate amount is recovered from the borrower.
#5 – Credit Information Bureau – Third-party agencies such as CIBIL keeps the record of the defaulters and financial health of the borrowers. Banks may seek the help of such agencies before lending money to them.
Limitations
NPA is the most important tool to find out the soundness, performance, and health of any bank or financial institution, as the more is the NPA, performance is low as compared to other banks or institutions, and the bank is less creditworthy. It creates a negative effect on the goodwill of a bank, and this can be judged only by total NPA. So it is a very important measure to be carried out. Mentioned below are some disadvantages –
- Reduced Income – With the increase in NPA assets, financial institution’s profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more reduces as it reduces the realization of assets.
- Falling Financial Strength – As NPA is nothing other than assets with reduced chances of realization, these directly affect the financial strength of a business.
- Disrepute to Business Image – It drastically affects the financial image of the organization.
- Falling Creditability – It adversely affects the image of lending institutions. As a result, lenders also do not show interest in lending due to the increased risk of non-repayment.
- Loss of Capital/Reserves – Due to increased chances of non-recovery, an organization not only loses future profitability but also incurs a loss of the principal amount granted.
Conclusion
Non-Performing Assets (NPA) are assets classified on the basis of non-recovery of installments as per the agreed terms and conditions, usually classified after 90 days of non-recovery. They are further classified as standard, sub-standard, doubtful, and lost assets. It has an adverse impact on the organization’s profitability, financial strength, capital adequacy, and public image. There are various government organizations set up under the parliament act or other statutes for monitoring NPA of financial institutions and thereby reducing NPA and increasing the profitability of the organization and the economy as a whole.
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