Non Performing Assets (NPA): Definition And Different Types

Non-Performing Assets (NPA): What happens when a bank lends money, but the borrower stops repaying? That’s where NPA (Non-Performing Asset) comes in. NPA meaning refers to loans where payments on principal or interest remain overdue for 90+ days.

As per RBI guidelines, any loan overdue beyond this period is classified as NPA in banking. These assets indicate financial stress and impact a bank’s stability. To align with global standards, India adopted the 90-day rule in 2004.

Understanding non performing assets is crucial for assessing a bank’s health. This guide covers what is NPA, its types, its impact, and how banks manage them to minimize financial risks.

What is NPA in Banking?

Banks earn money by lending loans and receiving interest. When a borrower stops making payments for 90+ days, the loan becomes a Non-Performing Asset (NPA)—it no longer generates income. NPA meaning in banking refers to loans that are overdue and at risk of default.

For example, if a company fails to pay its loan for three months, the bank marks it as an NPA. NPA full form is Non Performing Asset, and it affects a bank’s profitability. To cover potential losses, banks must set aside funds, impacting financial stability. Managing non performing assets is crucial for a healthy banking system.

How Non-Performing Assets (NPA) Work?

An NPA occurs when a borrower fails to repay the loan or interest for 90 days or more. For example, if a person misses payments on a car loan for three months, the bank classifies the loan as an NPA.

Once a loan becomes an NPA, it stops generating income for the bank. The bank may try to recover the money by selling any collateral, like a car or property, that was used to secure the loan.

Additionally, the bank sets aside provisions to cover the potential losses from these bad loans, reducing the funds available for other loans. This affects the bank’s ability to lend and impacts its financial health. Managing NPAs is crucial for the bank’s stability and profitability.

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Types of Non Performing Assets (NPA) in Banking

Non-performing assets (NPAs) are classified into three main types based on how long the loan has been overdue and the likelihood of recovery. These classifications help banks understand the level of risk and the possibility of recovering the funds. Here are the main 3 types of non performing assets:

1. Sub-Standard Assets (Up to 12 Months Overdue)

Sub-standard assets are loans that have been overdue for less than or equal to 12 months. At this stage, there’s still a chance that the borrower will resume payments, and the loan can potentially be recovered. However, these assets are considered risky.

For example, if a borrower misses monthly payments for a few months, but starts making payments again within 12 months, the loan would remain in this category.

2. Doubtful Assets (More than 12 Months Overdue)

When an asset has been overdue for more than 12 months, it is classified as a doubtful asset. The likelihood of recovery decreases significantly at this stage, and the bank may need to set aside provisions to cover potential losses. These loans are considered highly risky.

For example, If a borrower has missed payments for over a year and hasn’t made any effort to repay, the loan will be classified as doubtful.

3. Loss Assets (Unlikely to be Recovered)

Loss assets are loans that are deemed unrecoverable after thorough evaluation by the bank. This could be due to the borrower’s inability to repay, or the collateral being of little value. In this case, the bank writes off the loan, acknowledging that the money will likely never be recovered.

For example, if a borrower has defaulted for over 3 years and all recovery efforts have failed, the loan would be classified as a loss asset.

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In banking, managing NPAs is crucial because high NPAs affect a bank’s profitability and overall financial health. Each NPA classification helps the bank take necessary actions to mitigate risks.

What is NPA Provisioning?

NPA provisioning is when banks set aside a portion of their profits to cover potential losses from non performing assets (NPAs). In simple terms, it’s like preparing for a rainy day by saving money in case loans turn bad. When a loan stops earning money for the bank (because the borrower isn’t paying), the bank needs to account for the possibility of a loss. Provisioning helps the bank manage this risk.

How Does NPA Provisioning Work?

Banks follow specific rules to decide how much they should set aside. The amount depends on the category of the NPA, such as sub-standard, doubtful, or loss assets.

For instance, loans that have been overdue for a longer period (more than 12 months) require a higher provision because they are riskier.

Different Banks, Different Rules:

Provisioning norms can also vary depending on the type of bank. Tier-I banks (larger, more stable banks) and Tier-II banks (smaller banks) have different requirements. Regulators like the Reserve Bank of India (RBI) and auditors help assess how much a bank needs to set aside.

Therefore, NPA provisioning ensures that banks remain financially stable and are ready to absorb any losses from non performing loans, keeping the banking system secure and reliable.

Understanding GNPA and NNPA

GNPA and NNPA are key indicators used to assess the health of a bank’s loan portfolio, focusing on non performing assets (NPAs). Here are the details on GNPA and NNPA with examples:

Gross Non-Performing Assets (GNPA)

GNPA stands for Gross Non-Performing Assets. It represents the total value of non-performing assets (NPAs) in a bank before any provisions are made. GNPA includes both the principal amount and the interest on loans that have become non performing. It gives a clear picture of the total exposure a bank has to non performing loans.

For example, if a bank has issued loans worth Rs 100 crore and Rs 20 crore of those loans are overdue, the GNPA for that bank will be Rs 20 crore.

Net Non-Performing Assets (NNPA)

NNPA stands for Net Non-Performing Assets. It is the value of NPAs after deducting the provisions the bank has made for potential losses. Provisioning is the money set aside by the bank to cover possible defaults on loans. Therefore, NNPA shows the actual impact of NPAs on the bank’s financial health.

For instance, if the bank’s GNPA is Rs 20 crore, and it has made provisions of Rs 5 crore, the NNPA will be Rs 15 crore.

Furthermore, GNPA and NNPA are vital for evaluating a bank’s asset quality and financial stability, with GNPA showing the total overdue amount and NNPA revealing the potential loss after provisions.

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What are NPA Ratios?

NPA ratios help banks and analysts assess how much of a bank’s loans are non-recoverable. These ratios are calculated by comparing the total NPAs (non-performing assets) with the total advances or loans given by the bank. Here are the two types of NPA Ratios:

GNPA Ratio: This ratio compares the total Gross NPA to the total Gross Advances.

GNPA Ratio = (Gross NPA / Gross Advances) × 100

NNPA Ratio: This ratio compares the total Net NPA to the total Net Advances.

NNPA Ratio = (Net NPA / Net Advances) × 100

These ratios help evaluate the proportion of loans at risk, with higher ratios indicating potential financial difficulties for the bank.

Impact of Non Performing Assets (NPA) on Banks and Borrowers

Non-performing assets (NPAs) can have significant consequences for both banks and borrowers. Here are the main effects:

1) Impact on Bank Profitability:

NPAs reduce a bank’s interest income, as loans no longer generate revenue. This can lead to a decrease in profits and can also affect the bank’s ability to expand.

For example, if a bank has high NPAs, it might need to set aside more provisions, further decreasing available funds for lending.

2) Increased Financial Strain on Banks:

As NPAs rise, banks face pressure to increase provisions for potential losses, limiting funds for new loans. This restricts financial flexibility and reduces profitability. Banks may also raise interest rates or reduce lending, impacting their growth.

3) Impact on Borrower Creditworthiness:

For borrowers, NPAs reflect an inability to repay loans, negatively affecting their credit score. This damage to creditworthiness can make it difficult to secure future loans or credit and even result in higher interest rates on subsequent borrowing.

4) Reputation Damage:

Continuous issues with NPAs can harm a bank’s reputation, shaking public trust and investor confidence. If the public perceives a bank as unstable, it can lead to a decrease in business, making it harder for the bank to attract new customers or retain existing ones.

5) Economic Impact:

On a larger scale, a high number of NPAs can slow down economic growth. As banks tighten their lending policies, the availability of credit in the market decreases, leading to reduced investments and overall economic activity.

This can also affect liquidity, as depositors may withdraw their funds in response to concerns about the bank’s financial health.

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However, Non-performing assets (NPAs) significantly affect both banks and borrowers, reducing bank profitability and liquidity, while damaging borrowers’ credit scores and borrowing potential. To study NPAs, focus on understanding their categories, key ratios like GNPA and NNPA, and the provisioning norms that banks use to manage potential losses.

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Non Performing Assets (NPA) FAQs

What is the full form of NPA?

NPA stands for Non-Performing Asset. It refers to loans or advances where the borrower has not paid the interest or principal for 90 days or more.

What are the different types of NPA?

There are three types of NPAs: Substandard Assets (overdue for ≤12 months), Doubtful Assets (overdue for >12 months), and Loss Assets (unrecoverable loans). These categories help banks assess risk and required provisioning.

Is NPA defined as 90 days or 180 days?

An NPA is classified when a loan's interest or principal payment remains overdue for 90 days or more.

What happens if my account becomes NPA?

If your account becomes an NPA, your credit score will drop significantly, making it difficult to secure future loans. Even if you are able to borrow, the terms may be less favourable.

How can I study NPA?

To understand NPA in banking, focus on its categories, ratios (GNPA and NNPA), and provisioning norms. You can also explore relevant courses, like the Post Graduate Certification in BFSI from PW Skills, to gain practical knowledge on managing NPAs and more.