First things first. NPA means Non-Performing Asset. So, simply put, it refers to an asset that is non-performing in nature. More simply, it is a term used to refer to assets that do not earn any profit. In general, an asset is a piece of a business from which you can earn some money. But when it stops doing so, then you can argue not to call it an asset anymore. But actually, the situation is a bit more complex.
The word NPA is used in financial institutions like banks. Any type of deposit from retail customers is considered to be a liability for a bank because one day the money has to be returned to its owners with some additional amount as interest. On the other hand, banks use the deposited money to lend to borrowing customers at a higher interest rate. Then this is called an asset as they are earning profit in the form of interest. So, from a banking perspective, loans and advances are assets and deposits are liabilities. Now, when these assets or the loans and advances stop earning profits (which is basically interest), then they are termed Non-Performing Assets (NPAs).
Some conditions determine if an asset can be called an NPA or not. As there are many types and sub-types of loans and advances, they have various repayment methods for different tenures. So, the conditions for NPAs also differ accordingly. Generally, an asset is considered an NPA when the customer isn’t repaying interest or installments for more than 90 days. Though most loans and advances (like term loans) have this criterion, this is not the case for all types. Take agricultural loans, for example, where the overdue period depends upon the crop type. Also, there are some special banks where a 180-day overdue tenure is set for some loans. Criteria for NPAs can be different but they are painful regardless of their type. The higher the percentage of NPAs, the more headache it gives.
That’s why every bank is very concerned regarding all the possibilities that can lead a credit towards becoming non-performing. There is a primary system to classify NPAs. Three categories of NPAs are: sub-standard, doubtful, and loss assets. Sub-standard assets are assets that are not performing for less than a year, whereas doubtful assets are not performing for more than a year. And assets that are officially accepted as never being repaid are called loss assets. Banks try different ways to prevent their NPAs from turning into loss assets. Restructuring the loan is a way to release or decrease the pressure of the debt from the debtor. Restructuring can be done by lowering the interest rate or extending the term. When the condition is not likely to get repaid, the lender can sell the collateral if the loan is secured. Even if the NPA doesn’t become a loss asset, it takes a lot of time and energy from the lender to manage it. So, this can be a nightmare for any financial institution.
Prevention is always much better than cure. NPA is no exception here. It’s better to be cautious and serious while lending money to a customer or a company, than to recover it, restructure it, or simply sell its collateral. If you’re a bank, then it’s really difficult to get your NPA to zero but it’s possible to decrease it to make it minimal. For that, you have to know the reasons that are causing the assets to turn non-performing. The condition of the economy of the nation as well as the world is a factor while political stability is also very important. The economic condition of the company or the person can indicate the chances too. There are some sectors which are considered riskier to lend to. Anyway, the most crucial factor that must not be compromised to reduce the NPA percentage is proper due diligence. Due diligence is the process of verifying all the relevant documents and reports of the customers. Checking every nook and cranny must be mandatory before sanctioning a credit. It’s hard to tell if the borrower would repay properly or not. It’s all about predicting the future. Future prediction is never completely perfect. But it’s possible to be perfect at whatever the lender can. Credit scores and credit ratings, followed by the present condition of the borrower, should not be overlooked. Banks have well-explained guidelines for due diligence in different types of loans and advances, which should be followed properly.
To run a bank smoothly, NPAs must be kept as low as possible. Sometimes, to get more business, banks can lend without going through all the steps. This increases the chance of defaults. As the banking system is the economic backbone of an economy, the good health of the banks must be taken care of to run the economy properly. So, NPA is a topic that should be discussed more and more. The spotlight on this topic should not be turned off.
very good topic