A non-performing asset (NPA) is a loan that a borrower defaults on or fails to repay. Generally, a financial institution declares an account as an NPA when the borrower misses multiple EMIs for an extended period.
Having a credit account declared as a non-performing asset has severe repercussions for the borrower and the institution. It hurts a borrower’s creditworthiness and decreases their credit score and adversely affects the lender’s reputation and financial standing.
Read on to learn what is NPA, how it works, its impact on the banking system, and more.
The full form of NPA in banking means a non-performing asset. Any loan for which the payment remains overdue for more than 90 days gets marked as an NPA. So, if the borrower has missed an EMI, then the lender will consider that as a minor default.
However, the account will be marked as an NPA if the borrower misses three consecutive EMIs (90 days). On the other hand, loans where the repayment is made on time are called standard assets.
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As per the RBI’s mandate, banks classify these NPAs into three categories:
These are loans that are due for more than 90 days or less than 12 months. As per RBI guidelines, this applies only when the loan terms have been re-negotiated and the borrower has not yet repaid the loan amount.
If the borrower has not made any payment toward the loan for more than 12 months, it is classified as a doubtful asset.
If the borrower defaults for an extended period of time, the lender marks the loan as a loss on the balance sheet. This loan becomes ‘uncollectible’, and its value is not worthy enough to be considered as a bankable asset. However, it is not written off wholly or in parts, and thus, may have some recovery value.
In addition to knowing the non-performing assets meaning and classification, knowing how an asset is declared as an NPA is important. In instances of non-payment, the lender offers a grace period of 90 days.
Following this, the lender will likely issue a notice to the borrower for auction of collateral to recover the loan amount. If the borrower still fails to repay the loan, the lender will mark it as an NPA. This eases the lender’s burden as they can remove such loans from their balance sheet.
However, lenders take precautions for such cases and keep a certain amount from their profits aside every quarter to deal with NPAs. With these provisions, banks keep their accounts and balance sheets protected.
To calculate the required provisions, the lender measures the number of NPAs using these two metrics:
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Any bad loans or non-performing assets, which is the NPA full form in banking, are unfavourable. This is because the interest from the loans is a source of income. So, NPAs negatively affect the lender’s income and profitability.
Furthermore, too many NPAs can have a negative effect on the bank’s reputation. This may lead to people withdrawing funds from the bank to protect their funds. If a bank runs short on funds, they cannot offer more loans. Thus, NPAs can affect the lender’s overall business.
To avoid losses, here are options available to lenders to recover NPAs:
With these facts in mind, you can understand that a non-performing asset can have a huge impact on the banking system. In addition, if you fail to repay your loan, and it gets marked as an NPA, your credit score will drop significantly. This will make it challenging for you to access credit in the future. So, ensure you get a loan that fits your repayment capacity.
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Non-performing assets can include loans, bonds, mortgages and credit card debts, which cannot be classified under bankable assets.
Banks classify NPAs into sub-standard, doubtful and loss assets, depending on how long the asset has remained unpaid.
Banks calculate NPA by dividing the NPAs by total loans. This generates an NPA ratio in the decimal form.