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Non Performing Assets- Definition, Types & Examples

NON PERFORMING ASSETS (NPAs)

 
 
 
Non-Performing Assets (NPAs), also known as bad loans, are loans or advances given by banks and financial institutions that have stopped generating income for the lender. An asset becomes classified as an NPA when the borrower fails to make interest or principal repayments for a specified period, typically 90 days or more
 
Key Features of NPAs:
  • Banks classify loans as NPAs when the borrower defaults on repayment for a specific period, usually 90 days. Different categories of NPAs exist based on the duration of default
  • NPAs negatively impact banks\' profitability and liquidity as the non-repayment of loans leads to a loss of interest income and also affects the bank\'s ability to lend further. It weakens the balance sheet and can affect the bank\'s financial health
  • NPAs can arise due to various reasons such as economic downturns, business failures, mismanagement, diversion of funds, or fraudulent activities.
  • The Reserve Bank of India (RBI) monitors NPAs in banks and sets guidelines and frameworks for their identification, classification, and resolution
  • The RBI conducts periodic asset quality reviews to assess the quality of assets held by banks and to ensure proper classification of loans
  • Banks employ various methods to resolve NPAs, including restructuring loans, recovery through legal means, selling NPAs to asset reconstruction companies (ARCs), and the Insolvency and Bankruptcy Code (IBC) process
  • High levels of NPAs in the banking sector can hamper credit flow to productive sectors of the economy, impacting overall economic growth
What were the reasons behind the rise of Non-Performing Assets in India?
 
The rise in Non-Performing Assets (NPAs) in India can be attributed to several factors:
 
  • Economic slowdowns, both domestically and globally, have impacted various sectors, leading to reduced business activities and financial stress for borrowers, resulting in defaults on loan repayments
  • Several large-scale infrastructure projects faced delays, cost overruns, and regulatory hurdles, leading to stressed assets in the banking sector
  • Specific sectors such as power, steel, textiles, and aviation faced challenges due to factors like policy issues, market fluctuations, changing global scenarios, leading to NPAs in these sectors
  • Delays in policy decisions, regulatory bottlenecks, and inconsistencies affected businesses, leading to financial stress and defaults on loans
  • In some cases, there were instances of poor corporate governance, mismanagement, and diversion of funds, resulting in the buildup of NPAs.
  • In some cases, borrowers intentionally defaulted on their loans, knowing that the legal process for recovery was slow and ineffective.
NPA (Non-Performing Assets) – Classifications

Non-Performing Assets (NPAs) in India are classified into three categories based on the duration of the default:

  1. Substandard Assets: Substandard assets are loans or advances where the repayment is overdue for a period of 90 days or more but does not exceed 12 months. These assets have existing weaknesses and carry a higher risk of loss to the bank if not rectified or resolved promptly. Banks typically set aside a higher provision for substandard assets.

  2. Doubtful Assets: Doubtful assets are those where the default in repayment exceeds 12 months. These assets have remained substandard for a certain period, and there is a high probability of losses associated with them. Banks need to make even higher provisions for doubtful assets to cover potential losses.

  3. Loss Assets: Loss assets are loans or advances where the losses have been identified by the bank, internal or external auditors, or the RBI inspection but have not been fully written off. These assets have negligible recovery prospects, and banks are required to fully write off the losses by making provisions against them.

 

NPA Classification Duration of Default Description
Substandard Assets 90 days to 12 months Repayment overdue for 90+ days but ≤ 12 months
Doubtful Assets Exceeds 12 months Repayment overdue for more than 12 months
Loss Assets Identified losses Loans with identified losses, negligible recovery

These classifications help banks assess the risk associated with their loan portfolios, make provisions for potential losses, and devise strategies to resolve NPAs effectively.

 

 

MCQs On Non-Performing Assets (NPAs)

Question: NPAs refer to:

A) Investments that yield low returns.
B) Assets that fail to generate income for a specific period.
C) Loans or advances where interest or principal repayments are overdue for a specified period.
D) Assets with declining market value.

Answer: C) Loans or advances where interest or principal repayments are overdue for a specified period.

Question: The asset classification norms for NPAs in Indian banks are regulated by:

A) Reserve Bank of India (RBI)
B) Securities and Exchange Board of India (SEBI)
C) Ministry of Finance
D) National Institution for Transforming India (NITI Aayog)

Answer: A) Reserve Bank of India (RBI)

Question: What is the impact of high NPAs on banks?

A) Improved credit rating.
B) Increased profitability.
C) Reduced liquidity and financial stability.
D) Higher lending capacity.

Answer: C) Reduced liquidity and financial stability.

Question: What is the \'Insolvency and Bankruptcy Code\' (IBC) primarily aimed at?

A) Facilitating easier loan disbursement.
B) Resolving insolvency and bankruptcy issues efficiently.
C) Reducing the rate of interest on loans.
D) Providing tax benefits to banks with high NPAs.

Answer: B) Resolving insolvency and bankruptcy issues efficiently.

Question: Which committee recommended the setting up of Asset Reconstruction Companies (ARCs) in India?

A) Narasimham Committee I
B) Narasimham Committee II
C) Raghuram Rajan Committee
D) Tandon Committee

Answer: A) Narasimham Committee I
 

Previous Year Questions

1.Consider the following statements: Non-performing assets (NPAs) decline in value when (UPSC CSE 2018 Paper 1)

1. Demand revives in the economy.

2. Capacity utilization increases.

3. Capacity utilization, though substantive, is yet sub-optimal.

4. Capacity utilization decreases consequently upon merger of unit.

Which of the above statement are correct?

A.1, 3 and 4 only

B.1, 2 and 4 only

C.1, 2 and 3 only

D.1, 2, 3 and 4

Answer (C)

The correct answer is C.1, 2 and 3 only.

Explanation:

  • Statement 1: When demand revives in the economy, companies are able to sell more products and generate more revenue. This leads to an improvement in their financial health and a reduction in their NPAs.

  • Statement 2: When capacity utilization increases, companies are able to produce more goods and services. This also leads to an improvement in their financial health and a reduction in their NPAs.

  • Statement 3: Even though capacity utilization is substantial, it may still be below the optimal level. This means that companies are not producing at their full potential, which can lead to an increase in NPAs.

  • Statement 4: When capacity utilization decreases as a result of a merger, it can lead to an increase in NPAs. This is because the merged company may not be able to utilize the combined capacity as effectively as the two separate companies did.

Therefore, statements 1, 2, and 3 are correct, while statement 4 is incorrect.