What are the Non-Performing Assets (NPA)?
Non-Performing Assets (NPA) refers to the classification of loans and advances in the books of a lender (usually banks) in which there is no payment of interest and principal have been received and are “past due”. In most of cases, debt has been classified as NPAs where the loan payments have been outstanding for more than 90 days.
- NPA is generally classified on the bank’s balance sheet, and the % of NPA out of the total advances has become a vital ratio for the banks to keep a check on before making the results public.
- More than 90 days where payment is due to the banks’ loans and advances move to NPA.
- In the term sheetIn The Term SheetThe term sheet is usually a non-binding agreement that contains all the essential points related to the investment like capitalization and valuation, stake to be acquired, conversion rights, asset sale./sanction letter of every loan, the period of default under which the loan will be classified as non-performing assets are generally mentioned.
- As we note from above, Bank of America has an NPA of around $4,170 million that has accrued for 90 days or more.
Non-Performing Assets (NPA) Example
For example, Company XYZ has taken a loan of $100 million from Bank ADCB on which it needs to pay $10,000 of interest every month for 5 years. Now on the borrower defaults on the payment for three consecutive months, i.e., 90 days, then the bank needs to classify the loan as a non-performing asset in their balance sheet for that financial yearBalance Sheet For That Financial YearA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company..
Types of Non-Performing Assets (NPA)
#1 – Term Loans
A term loan, i.e., plain vanilla debt facility will be treated as an NPA when the principal or the interest installment of the loan has been due for more than 90 days.
#2 – Cash Credit and Overdraft
Cash credit or an overdraftOverdraftOverdraft is a banking facility that offers short-term credit to the account holders by allowing them to withdraw money from their savings or current account even if their account balance is or below zero. Its authorized limit differs from customer to customer. when remaining past due for more than 90 days can be treated as an NPA.
#3 – Agricultural Advances
Agricultural advances that have been past due for more than two crop seasons for short crop duration or one crop duration for long duration crops.
There could be various other types of NPAs, including residential mortgage, home equity loans, credit card loans, and non-credit card outstandings, direct and indirect consumer loansConsumer LoansA consumer loan is a type of credit given to a consumer to finance specified set of expenditures. The borrower must pledge a specific asset as collateral for the loan, or it may be unsecured depending on the loan's monetary value..
Classification of NPA for Banks
Banks classifies the non-performing assets (NPA) into the following type of four broad groups: –
#1 – Standard Assets
Standard assets are those assets which have remained NPA for 12 months or less than 12 months, and the risk of the asset is normal
#2 – Sub- Standard Assets
For more than 12 months, NPA is classified under sub-standard assets. Such kinds of advances possess more than normal risk, and the creditworthiness of the borrower is quite weak. Banks are generally ready to take some haircut on the loan amounts which are categorized under this asset class
#3 – Doubtful Debts
For a period which is exceeding 18 months, non-performing assets come under the category of Doubtful Debts. Doubtful debts itself means that the bank is highly doubtful of the recovery of its advances. The collection of such kinds of advances is highly questionable, and there is the least probability that the loan amount can be recovered from the party. Such kind of advances put the bank liquidity and reputation at jeopardy
#4 – Loss Assets
The final classification of non-performing assets is loss assets. This loan is identified either by the bank itself or an external auditorExternal AuditorExternal Audit is defined as the audit of the financial records of the company in which independent auditors perform the task of examining validity of financial records of the company carefully in order to find out if there is any misstatement in the records due to fraud, error or embezzlement and then reporting the same to the stakeholders of the company. or internal auditor as that loan where amount collection is not possible, and a bank has to make a dent in its balance sheet. The Bank, in this case, 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. the entire loan amount outstanding or need to make a provision for the full amount which needs to write off in future
Things Banks need to Bear in Mind Before Making Loan Advances
Following are the things banks need to bear in mind before making loan advances: –
#1 – Character
The character of the borrower needs to judge, and the willingness of the company to repay debt needs to ponder upon. The management, history, revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions. pipelines, stock performance and media coverages of the company should be taken into consideration to rightly make an opinion about the company
#2 – Collateral
The value of the collateral which has been pledged needs to be assessed, and proper valuation of the property/asset should be done keeping the loan to value ratioLoan To Value RatioThe loan to value ratio is the value of loan to the total value of a particular asset. Banks or lenders commonly use it to determine the amount of loan already given on a specific asset or the maintained margin before issuing money to safeguard from flexibility in value. in mind
#3 – Capacity
The capacity that the banker should analyze the company’s financials and the future revenue projections of the company. Also, existing lenders who are already on the company’s balance sheet needs to be studied properly to get the right collateral before providing advances
#4 – Condition
At last, the overall environment and the market and industry condition should be kept in mind. A Bank should consider and need to analyze in detail the external and internal factors that can affect the business in the future.
Big credit analysisCredit AnalysisCredit analysis is the process of drawing conclusions about an entity's creditworthiness based on available data (both quantitative and qualitative) and making recommendations about perceived needs and risks. Credit analysis also involves identifying, assessing, and mitigating risks associated with an entity's failure to meet financial commitments. firm judge any company in the 4C’s parameter
The Banks are the backbone of an economy which needs to strive in this dynamic and challenging environment. Hence choosing the right clients and business partners will make the economy sustainable and will save the world from another 2008 global financial crisis. For non-performing assets, a proper strategy and restrictions should be kept on the banks should limited credit is only available and is available to only those corporations who deserve it.
Non-Performing Assets (NPA) Video
This article has been a guide to what are Non-Performing Assets (NPA). Here we discuss the top types of NPA and classifications of Non Performing Assets in banks. You may also take a look at the below useful articles:-