Lending money is a risky affair! When you lend your money to someone, you have three situations: either receive the money in full, receive only half or none at all. While we might slate them as ‘loss’ or ‘bad debt,’ banks use a different term.
Banks refer to such debts as NPA or Non-Performing Assets. But, what exactly are they? What are their types? Let’s figure it out!
What Is A Non-Performing Asset?
Non-performing assets refers to when a borrower stops paying the sum due (interest or principal) to the lender, making them lose money.
As per the RBI, assets that stop generating income for the banks become non-performing assets. As per the definition:
‘A non-performing asset (NPA) is an advance or a loan, the interest or principal for which has been overdue for 90 days.’
NPA Provisioning As Per Banks
Leaving the technical definition aside, provisioning refers to the sum of money that the bank keeps aside for non-performing assets share of profit for a particular quarter. This way, the institution prepares for its assets which might turn to losses in the future. This way, banks keep an account of bad assets to maintain healthy sums in the book of accounts.
The provisioning of an asset depends on the type of category to which it belongs to. They can be categorized into:
There are different types of non-performing assets depending on how long they remain in the NPA category.
a) Sub-Standard Assets
A sub-standard asset can be classified as an asset that remains as a non-performing asset for a period equal to or less than 12 months.
b) Doubtful Assets
Assets can be classified as doubtful assets when they’ve remained as an NPA for a period of over 12 months.
c) Loss Assets
Loss assets are referred to as products that are “uncollectible” or have such a low value that it isn’t suggested as a bankable asset. However, such assets may have some recovery value left in them as they’ve not been written off yet.
Gross NPA Vs. Net NPA
Similar to accounting, Gross NPA refers to the total value of NPAs where the amount provisioned is not deducted.
To simplify the term, Net NPA can be referred to as the Gross Non-Performing Asset, less the provision which was left aside. This way, banks can easily calculate the overall value of their loan book.
For instance, a bank that loaned out Rs. 200 Crores created a provisioned amount of Rs. 40 Crores. This way, at the first financial year’s end, the institution was able to collect Rs. 160 Crores only.
So, to provide the calculation, the overall default for the financial institution now stands at Rs. 160 Crores as its Gross NPA.
The formula to calculate Net NPA is:
Net NPA = Gross Non-Performing Asset – Provisional Reserves
Here, Gross Non-Performing Asset (total NPA) of Rs. 160 Crores – provision of Rs. 40 Crores = Rs. 120 Crores (Net NPA).
How are NPAs reflected Over Bank’s Balance Sheets?
- If the period of non-payment has been over the stated time, banks are entitled to either liquidating the asset which was pledged during the loan period. Or, the sum assured will be written off as a bad debt, leading to payments collected through tribunals.
- The lender is entitled to take proactive steps to restructure the loan amount.
- The bad loans of lenders can be converted to equity.
To Sum Up!
NPAs or non-performing assets are a primary part of the accounting system. Depending on their value, NPAs can affect the functioning of a bank and other similar financial institutions. Having said that, we hope that you now have a precise idea of the term NPA, its different types, and its overall impact.
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