3.6 Non Performing Assets - Meaning, Causes, computation, Assessment and Impact of NPA's on Banking Se.pptx

Non Performing Assets - Meaning, Causes, computation, Assessment and Impact of NPA's on Banking

1. 3.6 Non Performing Assets - Meaning, Causes, computation, Assessment and Impact of NPA's on Banking Sector`

2. Non-performing assets (NPA) are loans or advances that have stopped generating any income for the bank because the borrower has stopped repaying the loan, i.e., the principal or interest amount is overdue for more than 90 days.

3. Causes of NPAs: Economic slowdown or recession: Decreased economic activity leads to businesses and individuals struggling to repay loans. Fraudulent practices by borrowers: Borrowers intentionally default on loans through deceptive actions. Political instability or regulatory changes: Changes in government policies or unstable political environments can disrupt borrower repayments.

4. 4. Natural calamities affecting the borrower's business: Disasters such as floods or earthquakes can damage businesses, impacting their ability to repay loans. 5. Mismanagement by the borrower: Poor financial decisions or operational missteps by borrowers result in loan defaults.

5. Computation of NPAs: Suppose a bank has provided loans to various borrowers, and some of these loans have become non-performing assets (NPAs). Let's consider the following scenario: Total Loans Given Out by the Bank: Rs. 100,00,000 (1 crore) Amount of NPAs: Rs. 10,00,000 (10 lakhs) To compute the NPA ratio: NPA Ratio = (Total Amount of NPAs / Total Loans Given Out) * 100 Using the example figures: NPA Ratio = (10,00,000 / 1,00,00,000) * 100 = (10 / 100) * 100 = 10% So, the NPA ratio for this bank is 10%. This means that 10% of the total loans given out by the bank have turned into non-performing assets.

6. Example Explanation: Let's say a bank has provided loans to various borrowers, including businesses and individuals. Some borrowers have failed to repay their loans due to financial difficulties, resulting in NPAs. For instance, a business might have defaulted on a loan of Rs. 10,00,000. Since the borrower hasn't made any repayments for an extended period, the loan has become an NPA. If the total loans given out by the bank amount to Rs. 1 crore and the total NPAs are Rs. 10 lakhs, the NPA ratio would be calculated as shown above, resulting in an NPA ratio of 10%. This indicates that 10% of the bank's loan portfolio is classified as non-performing assets.

7. Assessment of NPAs: Assessing NPAs involves identifying loans that have become non-performing and measuring their impact on the bank's financial health. In India, NPAs are assessed based on the guidelines provided by the Reserve Bank of India (RBI), which sets the regulatory framework for banks. As per the RBI's guidelines, a loan is classified as an NPA if the borrower fails to make interest or principal payments for a period of 90 days or more. Banks are required to regularly classify their assets as per the RBI's guidelines and disclose the NPA classification in their financial statements. The assessment of NPAs involves categorizing them into different categories based on the severity of the default, such as : Standard Assets: Explanation: Standard assets are loans or advances where the borrower is making regular interest and principal repayments within the specified time frame. These assets pose the lowest risk to the bank. Example: A borrower has taken a loan of Rs. 50,00,000 from a bank for a business venture. The borrower is consistently making monthly payments of interest and principal according to the loan agreement.

8. 2.Substandard Assets: Explanation: Substandard assets are loans where the borrower has delayed payments, and the bank anticipates some loss but believes that there is still a chance of recovery with additional efforts. Example: A borrower has taken a loan of Rs. 20,00,000 from a bank for purchasing machinery for a factory. The borrower has missed a few monthly payments, but the bank believes that with some restructuring of the loan or additional efforts, they can recover most of the outstanding amount.

9. 3. Doubtful Assets: Explanation: Doubtful assets are loans where there is a high degree of uncertainty regarding the full recovery of the outstanding amount. There are significant doubts about the borrower's ability to repay, and recovery efforts are challenging. Example: A borrower has taken a loan of Rs. 10,00,000 from a bank to expand their business. The borrower has defaulted on multiple payments, and there are indications that the business is struggling. The bank considers the chances of full recovery to be uncertain. 4. Loss Assets: Explanation: Loss assets are loans where the bank has determined that there is little or no chance of recovery. These assets are written off by the bank as a loss, and provisions are made to cover the expected loss. Example: A borrower has taken a loan of Rs. 5,00,000 from a bank to start a small retail business. However, the business failed, and the borrower declared bankruptcy. After exhausting all recovery efforts, the bank determines that there is no possibility of recovering the outstanding amount.

10. Impact of NPAs on the banking sector in India: The high levels of NPAs in the banking sector in India have several adverse impacts, including: Financial Losses: NPAs lead to financial losses for banks as they are unable to recover the principal and interest amounts from borrowers. This results in a decrease in the profitability and capital adequacy of banks, which may affect their ability to lend and expand their business. Reduced Lending Capacity: Banks with high levels of NPAs may face restrictions on their lending capacity as they need to set aside provisions to cover the potential losses from NPAs. This may lead to reduced credit availability to borrowers, particularly small and medium-sized enterprises (SMEs) and individuals, which can impact economic growth.

11. Increased Provisioning Requirements: Banks are required to make provisions for NPAs as per the RBI's guidelines, which involves setting aside a portion of their profits to cover the potential losses from NPAs. Higher provisioning requirements reduce the profitability of banks and erode their capital base, which may impact their ability to raise funds and expand their operations. Operational Challenges: Managing NPAs requires significant efforts and resources from banks, including legal proceedings, recovery measures, and loan restructuring. This may divert banks' attention and resources from their core banking operations and impact their overall efficiency and effectiveness.

12. Reputational Risk: High levels of NPAs can adversely impact the reputation of banks, eroding depositor confidence and investor trust. This can result in a loss of customers, difficulty in attracting new customers, and a negative impact on the bank's brand image. Systemic Risk: The high levels of NPAs in the banking sector can pose systemic risks to the stability of the entire financial system. If NPAs are not effectively managed, they can lead to contagion effects, impacting other banks and financial institutions and creating a systemic risk that can have far-reaching consequences on the economy.

13. Non-Performing Assets (NPAs) are a major concern for banks and financial institutions in India. To address the issue of NPAs, the Indian government and Reserve Bank of India (RBI) have taken several measures over the years. Some of the key measures are: Insolvency and Bankruptcy Code (IBC): The IBC was introduced in 2016 to expedite the resolution of bad loans in a time-bound manner. Under this code, an insolvent company can be taken to the National Company Law Tribunal (NCLT) for resolution. Asset Quality Review (AQR): In 2015, the RBI introduced AQR to ensure that banks recognize and disclose bad loans on their books accurately. AQR helped banks identify NPAs and take corrective measures to resolve them.

14. 3.SARFAESI Act: The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act was introduced in 2002. Under this act, banks can recover their dues from defaulters without the intervention of the court. 4. Debt Recovery Tribunals (DRTs): DRTs were set up to help banks recover their dues from defaulters. Banks can approach DRTs to recover their dues if the borrower defaults on the loan.

15. 5. 5/25 Scheme(The 5/25 Scheme was a refinancing program introduced by the Reserve Bank of India (RBI) in 2014. The scheme was designed to help banks restructure long-term infrastructure loans and provide relief to the infrastructure sector, which was facing challenges in meeting their debt obligations. Under the 5/25 Scheme, banks could extend the tenure of their long-term loans to up to 25 years and restructure the loan every five years.) : The RBI introduced the 5/25 Scheme in 2014 to help banks restructure long-term loans. Under this scheme, banks can extend the tenure of the loan to up to 25 years and restructure the loan every five years.

16. 6. Strategic Debt Restructuring (SDR): SDR was introduced in 2015 to help banks convert their debt into equity in defaulting companies. This helps banks take over the management of the company and turn it around.

17. 7.One Time Settlement (OTS): Banks can offer a one-time settlement to borrowers who have defaulted on their loans. Under this scheme, the borrower can settle their dues with the bank by paying a lump sum amount, which is usually lower than the outstanding loan amount. These measures have helped banks and financial institutions in India to recover their dues and resolve the issue of NPAs. However, there is still a long way to go, and the government and RBI continue to introduce new measures to address the issue.