Banks provide loans and advances to their customers. The bank earns interest on these loans. Therefore, loans and advances are assets of the bank. If a customer doesn’t pay interest or principal, then loan becomes bad loan or bad asset or non-performing asset.
Categories of Assets of Bank
The assets of the bank are classified into two categories:
- Performing Assets
- Non-Performing Assets:
Performing Assets or Standard Assets
These are those assets which bring returns to the bank. These are also called standard assets
Non-Performing Assets (NPA)
The asset which does not provide any income to the bank is called a non-performing asset. When the bank is not able to recover the interest on loan or the principal amount or both for a period specified by RBI, the asset becomes a non-performing asset. As per the prevailing prudential norms on advances, such asset on which the bank has not received interest and/or principal and/or both for more than 90 days, is categorized as non-performing asset.
The Reserve Bank of India has defined Non-performing Assets as an asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.
A non-performing asset (NPA) is a loan or an advance where;
- Interest and/ or instalment of principal remains overdue for a period of more than 90 days in respect of a term loan,
- The account remains ‘out of order’ in respect of an Overdraft/Cash Credit (OD/CC),
- The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,
- The instalment of principal or interest thereon remains overdue for two crop seasons for short duration crops,
- The instalment of principal or interest thereon remains overdue for one crop season for long duration crops,
- The amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of the Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021 as amended from time to time.
- In respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment.
The banks should not charge and take to income account interest on any NPA..
Categories of NPA (Non-Performing Asset)
On the basis of the period for which the asset has been non-performing, NPA can be categories into following categories:
- Sub-standard Asset: If an asset remains in the NPA category for a period less than or equal to 12 months, it becomes a sub-standard asset
- Doubtful Asset: if an asset has remained in substandard category for more than 12 months, then it becomes a doubtful asset.
- Loss Asset: A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection, but the amount has not been written off wholly.
Classification as Special Mention Account (SMA)
SMA is an account which is exhibiting signs of incipient stress resulting in the borrower defaulting in timely servicing of her debt obligations, though the account has not yet been classified as NPA.
The banks classify loans as SMA as under:
- SMA-0: Principal or interest payment or any other amount wholly or partially overdue for Up to 30 days
- SMA-1: Principal or interest payment or any other amount wholly or partially overdue for More than 30 days and up to 60 days
- SMA-2: Principal or interest payment or any other amount wholly or partially overdue for More than 60 days and up to 90 days
In case of revolving credit facilities like cash credit, the SMA sub-categories are classified as follows:
- SMA-1: Outstanding balance remains continuously in excess of the sanctioned limit or drawing power, whichever is lower, for a period of More than 30 days and up to 60 days
- SMA-2: Outstanding balance remains continuously in excess of the sanctioned limit or drawing power, whichever is lower, for a period of More than 60 days and up to 90 days
Upgradation of NPA Accounts
The loan accounts classified as NPAs may be upgraded as ‘standard’ asset only if entire arrears of interest and principal are paid by the borrower. In case of borrowers having more than one credit facility from a bank, loan accounts shall be upgraded from NPA to standard asset category only upon repayment of entire arrears of interest and principal pertaining to all the credit facilities.
Provisioning
Provisioning is a practice adopted by banks in which they set aside certain portion of funds from their profits for bad assets.
The provisioning is made on the assets on the basis of classification of assets as under:
- Standard Assets
- Sub-standard Assets
- Doubtful Assets
- Loss Assets
Provisioning on Standard Assets
The standard asset provisioning requirements are as follows:
- Direct advances to Agriculture and SME sectors – 25%
- Commercial Real Estate (CRE) sector – 1%
- Commercial Real Estate-Residential Housing Sector (CRE-RH) – 75%
- All other loans and advances not included above – 40%
Provisioning on Sub-Standard Assets
A general provision of 10% on total outstanding should be made without making any allowance for ECGC guarantee cover and securities available.
Provisioning on Doubtful Assets
The provisioning on doubtful assets are classified into two categories:
- Unsecured Advances: The advance which is not covered by the realisable value of the security, but to which the bank has a valid recourse, the Provision should be 100%.
- Secured Advances: In regard to the secured portion, provision may be made on the basis of Period for which the advance has remained in ‘doubtful’ category:
- Upto one year in Doubtful category – 20%
- One to Three years in Doubtful category – 30%
- In Doubtful category for more than three years – 100%
Provisioning on Loss Assets
The provisioning on loss assets should be 100% of the outstanding.
Causes of NPA (Non-Performing Asset)
The causes of growing NPA can be classified into External and Internal factors.
External Factors
- Failure of the Business Activity
- Willful default
- Natural Calamities
- Unhealthy Competition
- Industrial Sickness
- Lack of Demand
- Ineffective Recovery Tribunal
- Recessionary Market Trend
- Government Policy for Financing Priority Sector
Internal Factors
- Defective Lending Process
- Mismanagement and Diversion of Funds
- Poor Credit Appraisal System
- Improper Selection of Borrowers/Activities
- Non-compliance of Sanction Terms and Conditions
- Unrealistic Repayment Schedule
- Lack of Inter-bank Co-ordination
- Absence of Regular Industrial Visits
- Lack of Proper Pre-appraisal and Follow-up
- Inappropriate Technology
- Improper SWOT Analysis
Impact of NPA on banks
- It reduces the profitability of banks due to increase and provisioning.
- It affects the credibility of bank and customer lose trust in bank. The depositors may withdraw their deposits and causes liquidity crunch to banks.
- It reduces the ability of banks to lend more and thus results in lesser interest income.
- The increase in NPA level adds to risk weighted assets which warrant the banks to shore up their capital base further.
- High level of NPA jolts the investors and shareholders confidence. The increased NPA level is likely to have adverse impact on the bank business as well as profitability thereby the shareholders do not receive a market return on their capital
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