The assets of the banks which don’t perform (that is – don’t bring any return) are called Non Performing Assets (NPA) or bad loans. Bank’s assets are the loans and advances given to customers. If customers don’t pay either interest or part of principal or both, the loan turns into bad loan.
According to RBI, terms loans on which interest or installment of principal remain overdue for a period of more than 90 days from the end of a particular quarter is called a Non-performing Asset. However, in terms of Agriculture / Farm Loans; the NPA is defined as under:
- For short duration crop agriculture loans such as paddy, Jowar, Bajra etc. if the loan (installment / interest) is not paid for 2 crop seasons , it would be termed as a NPA.
- For Long Duration Crops, the above would be 1 Crop season from the due date.
Provisioning Coverage Ratio
For every loan given out, the banks to keep aside some extra funds to cover up losses if something goes wrong with those loans. This is called provisioning. Provisioning Coverage Ratio (PCR) refers to the funds to be set aside by the banks as fraction to the loans.
Standard Asset
If the borrower regularly pays his dues regularly and on time; bank will call such loan as its “Standard Asset”. 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.
However, if things go wrong and loans turn into bad loans, the PCR would increase depending up the classification of the NPA as discussed in next section.
Classification of the NPAs
Banks are required to classify nonperforming assets further into three main categories (Sub-standard, doubtful and loss) based on the period for which the asset has remained non performing. This is as per transition of a loan from standard loan to loss asset as follows:
- If the borrower does not pay dues for 90 days after end of a quarter; the loan becomes an NPA and it is termed as “Special Mention Account”. If this loan remains SMA for a period less than or equal to 12 months; it is termed as Sub-standard Asset. In this case, bank has to make provisioning as follows:
- 15% of outstanding amount in case of Secured loans
- 25% of outstanding amount in case of Unsecured loans
- If sub-standard asset remains so for a period of 12 more months; it would be termed as “Doubtful asset”. This remains so till end of 3rd year. In this case, the bank need to make provisioning as follows:
- Up to one year: 25% of outstanding amount in case of Secured loans; 100% of outstanding amount in case of Unsecured loans
- 1-3 years: 40% of outstanding amount in case of Secured loans; 100% of outstanding amount in case of Unsecured loans
- more than 3 years: 100% of outstanding amount in case of Secured loans; 100% of outstanding amount in case of Unsecured loans
- If the loan is not repaid even after it remains sub-standard asset for more than 3 years, it may be identified as unrecoverable by internal / external audit and it would be called loss asset. An NPA can declared loss only if it has been identified to be so by internal or external auditors.
Example of NPA
We suppose that a party was 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 Sub-standard 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 of the NPAs on Banks
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. 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.
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. When a borrower makes any default in repayment and his account is classified as NPA; the secured creditor has to issue notice to the borrower giving him 60 days to pay his dues. If the dues are not paid, the bank can take possession of the assets and can also give it on lease or sell it; as per provisions of the SAFAESI Act.
Reselling of NPAs
If a bad loan remains NPA for at least two years, the bank can also resale the same to the Asset Reconstruction Companies such as Asset Reconstruction Company (India) (ARCIL). 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. They purchase such loans on low amounts and try to recover as much as possible from the defaulters. Their revenue is difference between the purchased amount and recovered amount.