Non-Performing Assets (NPAs)

Meaning of NPAs

A performing asset is an advance that generates income for a bank in the form of interest or other charges. By contrast, a non-performing asset (NPA) is an advance that ceases to generate income.

• When a borrower fails to repay the principal and/or interest for a specified period, the loan is classified as an NPA.
• In a narrower sense, an NPA is an asset that does not contribute to corporate profits or yield positive returns.
• While loans and advances fall squarely under this definition, some assets like cash balances, though non-earning, are still essential for banking operations and cannot be treated as NPAs.

Definitions of NPAs

1. General Definition: An asset, including a leased asset, becomes non-performing when it stops generating income for the bank.
2. Narasimham Committee (1991):
   • Defined an asset as NPA if interest or instalments of principal remained unpaid for more than 180 days.
3. Prudential Norms (RBI):
   • Any asset, including a leased asset, that fails to generate income is classified as NPA.
4. RBI Guidelines:
   • NPAs include sub-standard assets, doubtful assets, and loss assets.
   • An asset usually becomes an NPA when it stops yielding income for a specified time.
5. SARFAESI Act, 2002:
   • Defined NPA as an asset or account of a borrower classified by a bank/financial institution as sub-standard, doubtful, or loss asset in accordance with RBI guidelines.

Evolution of RBI Norms on NPA Recognition

RBI progressively tightened norms for NPA recognition to align with international best practices:

Year (ending March 31)	Specified Period for Classification as NPA
1993	4 Quarters (12 months)
1994	3 Quarters (9 months)
1995 onwards	2 Quarters (6 months)
2001	180 Days
2004 onwards	90 Days

• Past Due Concept: Earlier, an amount was considered “past due” if unpaid within 30 days of due date. This concept was withdrawn in March 2001.
• Current Norm: Since March 31, 2004, an advance is treated as NPA if interest and/or principal remain overdue for more than 90 days.

Special Cases in NPA Classification

1. ‘Out of Order’ Accounts:
   • In Cash Credit (CC)/Overdraft (OD) accounts, if the outstanding balance continuously exceeds the sanctioned limit/drawing power, or if there is no regular credit, the account is treated as “out of order.”
2. Overdue:
   • Any amount due but not paid on the due date fixed by the bank is considered overdue.
3. Cash Credit/Overdraft Accounts:
   • Classified as NPA if they remain “out of order” for two quarters or more as on the balance sheet date.
4. Bills Purchased/Discounted:
   • If bills remain unpaid for two quarters or more from their due date, they are treated as NPAs.

Classification of Non-Performing Assets (NPAs)

Banks are required to assess the quality of their assets to evaluate overall performance and financial health. Based on the recommendations of the Narasimham Committee (1991), the Reserve Bank of India (RBI) revised the framework for asset classification.

According to RBI guidelines, bank advances are divided into four broad categories:

1. Standard Assets (Performing Assets)
2. Sub-standard Assets (Non-Performing Assets)
3. Doubtful Assets (Non-Performing Assets)
4. Loss Assets (Non-Performing Assets)

Among these, the first category is treated as performing, while the other three are considered non-performing assets (NPAs).

1. Standard Assets

• These are performing assets, meaning they generate continuous income and repayments are made on time.
• They carry a normal degree of risk.
• Since they are not NPAs in the real sense, no special provisions are required.

2. Sub-Standard Assets

• Prior to 2001: Loans that remained NPAs for not more than two years.
• After 31 March 2001: Assets that have remained NPAs for a period less than or equal to 18 months.
• In such cases, the borrower’s net worth or value of security is insufficient to ensure full recovery of bank dues.

3. Doubtful Assets

• Prior to 2001: Loans that remained NPAs for more than two years.
• After 31 March 2001: Assets classified as NPAs for a period exceeding 18 months.
• Recovery of dues in full is highly uncertain and depends on future events.

4. Loss Assets

• Assets where loss has been clearly identified by the bank, RBI inspectors, or auditors.
• Such assets are considered uncollectible and of little value, though they may not yet have been fully written off in the bank’s books.

Types of NPAs

1. Gross NPA

• The total amount of loan assets classified as NPAs by banks as per RBI guidelines on the balance sheet date.
• It includes all non-standard assets: sub-standard, doubtful, and loss assets.
• Indicates the overall quality of loans made by a bank.

2. Net NPA

• Derived by deducting provisions made against NPAs from Gross NPAs.
• Reflects the actual financial burden on banks.
• Provides a more realistic picture of a bank’s asset quality.

Reasons for Growing Non-Performing Assets (NPAs)

The rise of NPAs is a global concern, but the problem is more acute in Public Sector Banks (PSBs) in India due to aggressive lending, lack of financial literacy among borrowers, and weak credit discipline. The causes can be grouped into external and internal factors.

1. External Factors

1. Failure of Business Activity: Projects or businesses financed by banks often fail, leaving borrowers unable to repay.
2. Willful Defaults & Frauds: Some borrowers deliberately avoid repayment or divert funds.
3. Natural Calamities: Irregular rainfall, floods, and droughts affect farm income, making agricultural loans risky.
4. Unhealthy Competition: Price wars and over-competition cause business losses, leading to defaults.
5. Industrial Sickness: Poor project design, weak management, lack of technology, and unstable policies push industries into losses.
6. Lack of Demand: Overestimation of demand results in unsold stock and inability to repay loans.
7. Ineffective Recovery Tribunals: Loan recovery tribunals often fail to act effectively, delaying recoveries.
8. Recessionary Trends: Economic downturns reduce firm revenues, sometimes leading to bankruptcy.
9. Priority Sector Lending Mandates: PSBs are required to lend to weaker sectors at subsidised rates; inefficiencies here often convert loans into NPAs.

2. Internal Factors

1. Defective Lending Practices: Sanctioning loans without proper evaluation of borrower capacity or project viability.
2. Mismanagement & Diversion of Funds: Borrowers misuse funds for unproductive purposes, reducing repayment ability.
3. Poor Credit Appraisal: Inadequate risk assessment leads to advances to weak borrowers.
4. Improper Selection of Borrowers/Activities: Lending to less creditworthy borrowers or unviable sectors.
5. Non-compliance with RBI Norms: Ignoring prescribed conditions for sanctioning loans increases default risks.
6. Unrealistic Repayment Schedules: Heavy repayment obligations that exceed borrower capacity.
7. Lack of Inter-bank Coordination: Absence of information-sharing allows borrowers to default with multiple banks simultaneously.
8. Weak Monitoring: Irregular industrial visits and poor follow-up reduce repayment discipline.
9. Inappropriate Technology: Outdated MIS and accounting systems weaken loan monitoring and recovery.
10. Improper SWOT Analysis: Weak assessment of borrower integrity, creditworthiness, and market risks.