An extensive look into how banks manage their non-performing assets

Before even talking about non-performing assets, it must be made clear that traditionally anything that can be sold in exchange for cash is considered an asset. In a 2007 circular about non-performing assets, RBI said that "An asset becomes non-performing when it ceases to generate income for the bank". While any asset can turn into a non-performing asset, from the point of view of the banking industry, any loans or advances made to a borrower will be considered an asset. Why? Because the borrower pays interest to the bank. When borrowers default on loans or fail to repay continuously (for 90 days), they are categorised as NPA for the bank/lender. In this case, what happens is that the bank acquires any collateral or other assets in order to settle their debts, also known as non-banking assets. Let us delve deeper into how this works.

What are Non-Performing assets?

Whenever bank loans/advances have defaults or arrears for a considerable period (90 days), they are classified as (NPA) non-performing assets. As defined by the RBI, any asset, including leased assets, becomes non-performing when it stops generating income for the bank. 

Earlier, there was a concept of "past due", where any amount that had not been cleared with the lending institution within 30 days was considered a default. Under this system, once this period has passed, the lender considered the loan agreements to be void, and the loans immediately became non-performing assets of banks. 

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Gross non-performing assets of banks

When a bank has a lot of non-performing or poorly performing assets and has a higher gross NPA ratio, it means the bank's financial health is in danger. This is because the gross NPA ratio gives an idea of how much of the bank's loans are at risk of non-repayment. Usually, if there is a default in interest payment for a term of more than 3 months, the loan turns into NPA.

non-performing assets examples

Suppose a company took out a Rs 2 crore loan from the bank. In case the company defaults to paying the Rs 100,000 monthly interest continuously for 3 months, then the lending institution will immediately identify this loan as a non-performing asset. Hence, on the quarterly balance sheet of the bank, this particular loan will be categorised as an NPA. 

Note: This loan/advance can be categorised as non-performing even after monthly interest payments if the company fails to pay the principal upfront on maturity.

The different types of NPA

NPAs can be of different types. Here is a classification of non-performing assets which are vastly different from each other. 

• Substandard assets- Assets that have remained non-performing for a period of 12 months or less.
• Doubtful Assets- Assets that have maintained their substandard category for 12 months or more.
• Loss Assets- Assets that cannot be recovered and offer very little value to the lender. Despite their meagre value, they no longer qualify as bankable assets.

Norms of provisioning

According to the law, the bank is liable to provide for a certain percentage of all non-performing or poor assets they are holding. These provisioning norms are being set and actively regulated by the RBI and are the same for all banks regarding NPAs. Take a look here:

• The bank is to provision for 10% of the unpaid amount without any budget for securities or without the cover of any type of government guarantee.
• NPAs in the substandard category are liable for another 10% coverage making the total coverage 20% on the remaining unpaid amount.
• The provisional requirement is a complete 100% for a doubtful or unsecured NPA.

Factors that contribute to non-performing assets (NPA)

Here are the various reasons that can cause assets to perform poorly:

1. Banks do not conduct a thorough background check before giving out loans to shoddy individuals and corporations, thereby taking very high risks.
2. The banks are not reflecting timely and adequately of how sufficient they are in terms of the loan amount, tenure or capital loss within a specific time frame.
3. The funds granted to the companies are being redirected somewhere else by the promoters of the companies.
4. The bank is trying to fund unrealistic and not viable projects at all.
5. Lack of communication regarding collecting and sharing credit information of applicants in private companies.
6. Debts could not be collected efficiently from overdue borrowers on their loans.

Impact of NPA

A high NPA rate can affect the banking system very severely. Not only that, the constant inability to repay loans can ring alarm bells for the borrower too. Here, we will take a side by side look into how a high gross NPA ratio impacts the system.

Impact on Banking System

• The profit of the bank is reduced.
• The capital adequacy of any bank/financial lending institution is badly affected.
• Banks tend to veer away from giving out loans with even minimal risk. This means that the flow of fresh credit into the banking system is hampered.
• The banks will tend to focus more on managing credit risks than making their lending business more profitable.
• Funds will start to cost more if the high NPA is not corrected.

Impact on borrowers

• Back-to-back, NPAs will hurt the creditworthiness of any individual or corporate, thus hurting their CIBIL score.
• Continued failure to repay loans paints a bad picture of the borrower, leading to future complications.
• An account with an NPA is already a red flag for banks. There is no doubt that any bank will be apprehensive about sanctioning loans to such a borrower.
• NPA does not only impact the borrower but its group entities too. This means that any company subsidiary will also face hurdles while getting loans sanctioned.

Preventive measures are taken to prevent NPA

Here is a complete checklist of the measures and regulations announced by RBI to stop the high percentage of non-performing assets:

• All banks should adhere to a strict timeline for planning for the resolution of loan defaults.
• Lenders should be liable for specific incentives for cooperating in resolution plans currently underway.
• The present restructuring plans and procedures will need a significant overhaul.
• In the future, when non-cooperative borrowers borrow from lenders, the agreement terms must be made more expensive in resolution.
• Sales of assets must be regulated more liberally.
• In case any loss is disclosed, lenders are allowed to divide the loss on the sales for a maximum of 2 years.
• Leverage buyouts by special entities will be allowed, especially when it comes to acquiring "stressed companies".
• All necessary steps are mandatory to ensure the better functioning of all Asset Reconstruction Companies.
• All private equity or sector wise companies will get help for playing an essential function in the stressed assets market.

We are sure you have a clear understanding of what non-performing assets are and how they can impact the banking and financial sector. As discussed in the article, both banks and borrowers must be more responsible for reducing the gross NPA ratio in the market. While banks need to be more vigilant about who they are sanctioning loans to, borrowers need to make sure that they will be able to repay the loan. Too many defaults will only hurt their credit score in the long run. Wish to know more about how the banking industry works? Get in touch with the latest in banking and finance in our blog section. If you need financial advice, you can contact NoBroker financial services, which can guide you in the right direction. 

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