Some Questions on NPAs

Classification of the NPAs:

The above is a general definition of the Non Performing Assets. Here, please note that the Banks are required to classify nonperforming assets further into three main categories based on the period for which the asset has remained non performing.

The three categories are:

1. Substandard Assets,
2. Doubtful Assets
3. Loss Assets.

The transition from the Standard asset to Loss Asset takes place as follows:

• Regular Asset / Standard Asset         Any Period
• Special Mention Account as NPA        90 Days
• Substandard Asset                 12 Months
• Doubtful                     Next 12 Months
• Loss                         Uncertain

A loss asset is uncertain but it must be identified as a loss. So, as a thumb rule, an account remains NPA for a period of 12 months it is classified under Substandard, if it remains Substandard for 12 months it is classified as Doubtful. A Loss Asset is one where loss has been identified by the internal or external auditors.

Now, let take a simple example:

We suppose that a party is disbursed a loan on January 1, 2010. Its due date is June 1, 2010. But the party does not make a payment. So

• It will be an Standard Asset from January 1, 2010 till June 1, 2010 (Due Date)
• It will be a Special Mention Account From June 2, 2010 till August 29, 2010 (90 days)
• It will be Substandard from August 30, 2010 till August 29, 2011
• It will be doubtful from August 30, 2011 till August 29, 2012

It may remain doubtful Asset for a period of 3 years, beginning from 12 months of being an NPA, but once the auditors identify it as a loss, it will be assigned a loss asset; however, the period may be anything above 3 years.

Implications:

1. The most important implication of the NPA is that a bank can neither credit the income nor debit to loss, unless either recovered or identified as loss.
2. If a borrower has multiple accounts, all accounts would be considered NPA if one account becomes NPA.

Gross NPA and Net NPA:

The NPA may be Gross NPA or Net NPA. In simple words, Gross NPA is the amount which is outstanding in the books, regardless of any interest recorded and debited. However, Net NPA is Gross NPA less interest debited to borrowal account and not recovered or recognized as income. RBI has prescribed a formula for deciding the Gross NPA and Net NPA.

Extra Funds:

Please note that the Banks have to keep aside extra funds for standard and NPA, called provisioning in banking parlance.

• As per the norms, banks have to make a general provision of 0.40% for all loans and advances except that given towards agriculture and small and medium enterprise (SME) sector.
  
• In case of NPAs, provisioning needs to be done as per the NPA category. For substandard loans, a general provisioning of 10% on the total outstanding amount is made if the loan is secured, for unsecured loans the total provisioning that needs to be done is 20% on the outstanding balance.
  

NPA and SARFAESI Act :

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act has provisions for the banks to take legal recourse to recover their dues.

Here is how this process is takes place:

1. A borrower makes any default in repayment and his account is classified as NPA.
   
2. The secured creditor has to issue notice to the borrower giving him 60 days to pay his dues.
   
3. If the dues are not paid, the bank can take possession of the assets and can also give it on lease or sell it.
   

Reselling of NPAs:

The NPAs can be resold as well. The purchasers are called Asset Reconstruction Companies such as Asset Reconstruction Company (India) (ARCIL).

• A bank can sell NPA from its books to asset reconstruction companies such only if it has remained NPA for at least two years.
  

These sales are only on Cash Basis and the purchasing bank/ company would have to keep the accounts for at least 15 months before it sells to other bank.

• Once the NPA is purchased, it is classified as Standard for a period of 90 days.
  

NPAs Current Position:

• Please note that as of now, the Gross Non Performing Assets as a ratio to gross advances from the commercial banks has increased from 2.25% in FY 2009 to 2.39% in FY10.
  

No business is without any risk and banks cannot be any exception. But the high quantum of NPAs is surely a cause for worry, especially when the economy is fast recovery and Indian banks have an important role to play for growth to be sustained.

In line with this, the Reserve Bank of India on 8 November 2010, while releasing the “Report on Trend & Progress of banking in India 2009-10” has warned the banks that cautioned that going ahead, management of non-performing assets (NPAs) and liquidity will become critical for banks.

“Apart from the increase in NPA ratio, there was also deterioration in the distribution of NPAs of commercial bank between 2009 and 2010. This was evident from an increase in the percentage of loss-making and doubtful assets of scheduled commercial banks (SCBs), which represented the lower end of the NPA spectrum. The shift in the distribution of NPAs in favor of doubtful and loss-making assets was more prominent in the case of foreign and new private sector banks as compared to public sector banks. ^{(Indian Express, November 10, 2010)} “