Financial institutions classify loans and advances on which the principal is past due and on which no interest payments have been made for a while as NPAs. Sit tight; let’s go on a journey together as we explain all that NPA entails.
What is meant by NPA in banking?
Let’s start by understanding what the full form of NPA is in the banking sector. It is an abbreviation for Non-performing assets, which are loans made by banks and other active financial institutions (lenders) that have interest payments and principal balances that have been past due for an extended period.
Note! The abbreviation of non-performing assets is the same in many countries, so you don’t have to figure out what the meaning of NPA in the banking sector is in Hindi, Marathi, and other languages.
In general, credits become NPAs when they have been unpaid for 90 days or more. Term loan’s installment or interest that has been overdue for more than this period may include:
- A Cash Credit/Overdraft on an account that is “out of order”.
- A bill that has been past due for more than 90 days.
- The quantity of cash that has been outstanding for a continuous 90 days.
The banks should be lucrative, just like any other business, yet NPA wipes away a sizable chunk of their margin. Non-performing assets are not the desired thing as they undermine the entire banking system.
Types of NPA
Depending on how long assets are classified as non-performing, they must be assigned by a bank or other lender as one of the following three types:
- Sub-standard asset
If an asset stays non-performing for a period less than or equal to 12 months, it is classified as a sub-standard.
- Loss asset
When an asset is “uncollectible” or has such little value that its continuation as a bankable asset is not recommended, it is seen as a loss. This asset has not been entirely or partially written off; hence there may yet be some recovery value in it.
- Doubtful asset
If the loan was an NPA for more than a year, it is considered questionable. In general, lenders have significant concerns about the borrower’s ability to ever return the entire debt. This category of NPA significantly impacts the bank’s own risk profile.
How NPAs work
The balance sheet of a bank or any other financial organization includes non-performing assets. Typically, the lender compels the borrower to liquidate any assets pledged as part of the loan agreement after an extended period of non-payment. The bank might also write off the debt as bad and then sell it at a loss to a collection agency if any assets were not pledged.
A loan may be designated as an NPA at any time before or after it is repaid. In most cases, debt is categorized as this after loan payments have been missed for 90 days or more. While this is the standard, the actual time frame may differ based on the conditions and particulars of each individual loan.
Assume that a business with a $17 million loan making interest-only payments of $75,000 a month misses three payments in a row. To comply with regulatory standards, the lender can be forced to classify the loan as non-performing. A corporation can also label a loan as non-performing if it makes all interest payments but cannot pay back the principal when it is due.
When non-performing assets, often referred to as non-performing loans, are included on the balance sheet, the lender is left with a significant burden. His cash flow is reduced when interest or principal are not paid, which can cause budgetary problems and lower revenues.
Loan loss provisions, which are set aside to cover potential losses, limit the capital available to make more loans to other borrowers. Realized losses from defaulted loans are subtracted from revenues. Therefore, if a bank accumulates a significant amount of NPAs on its balance sheet over time, regulators can tell that the bank’s financial viability is in threat.
Non-performing assets provisioning
Provisioning refers to the sum banks set aside from their earnings or profits in a given quarter to cover non-performing assets, which could eventually result in losses. It is a technique used by lenders to account for problematic assets and keep a clean ledger.
Provisioning is carried out depending on which of the three categories the asset falls within. The type of lender also affects the process. For instance, the provisioning standards for Tier-I and Tier-II banks differ.
Effect of NPAs on financial operations
The banking system is getting worse as a result of the emergence of a large number of NPAs. Their impact includes:
- A decrease in the capital adequacy of a bank or other financial organization.
- The reluctance of banks to make loans and assume risk.
- The decline in profits of banks.
Ultimately, the major impact of non-performing assets is that lenders now prioritize managing credit risks instead of focusing on growing their businesses.
We hope that we were able to explain in simple terms what the meaning of NPA is in banking. Lenders do not benefit from having non-performing assets because they are underperforming. In the hopes of someday recovering them, banks can either maintain NPAs on their books or make provisions.
Non-performing assets indicate that lender has an excessive number of credits that are either no longer operational or are not generating any interest income for it. However, NPA is far from the only essential criterion for evaluating a bank.