The health as well as the financial condition of a bank is measured through the quality of assets in its balance sheet. A high proportion of the assets that is not returning or Non-Performing Assets is a matter of concern for any financial institution.
Simply, NPA indicates the amount of loan that was not returned by the customer. An asset becomes non-performing when it ceases to generate income for the bank.
As per the current norm, if a loan is overdue for more than 90 days, it will be categorized as a Non-Performing Asset (NPA). A loan whose interest and / or installment of principal have remained ‘overdue due’ for a period of more than 90 days is thus considered as NPA. Overdue is a situation where the loan is not paid by the due date fixed by the bank.
From the banks’ health point of view, higher the NPA, lower will be its health. Attempt to strengthen a bank is mainly concentrated on NPA management.
Assets are classified in terms of their periodic return or repayment status. There is the standard assets where periodic timely repayment has been occurring. The NPA, substandard asset, doubtful asset and loss asset shows worsening of asset quality.
See the RBI’s April 2023 regulation for NPA in detail: https://rbi.org.in/scripts/NotificationUser.aspx?Mode=0&Id=12472.
How assets are classified?
Assets of a bank are classified in terms of its repayment status. Standard assets, Non-Performing Assets, Substandard assets, Doubtful assets and Loss assets are the classifications of asset quality.
For a bank, classification of assets into different categories should be done taking into account credit weaknesses and the extent of dependence on collateral security for realization of dues.
Banks should report the figures of NPAs to the Regional Office of the Reserve Bank at the end of each year within two months from the close of the year in the prescribed proforma.
What is a Non-performing Asset (NPA)?
An asset becomes non-performing when it ceases to generate income for the bank.
Any asset that is not returning in the form of principal or interest for more than 90 days will be considered as NPA.
A loan whose interest and / or installment of principal have remained ‘overdue due’ for a period of 90 days is thus considered as NPA. Overdue is a situation where the loan is not paid by the due date fixed by the bank.
Banks should identify their assets into the following broad groups.:
(i) Standard Assets
(ii) Sub-standard Assets
(iii) Doubtful Assets
(iv) Loss Assets
Standard Asset is one which does not disclose any problems, and which does not carry more than normal risk attached to the business. Such an asset should not be an NPA.
A substandard asset would be one, which has remained NPA for a period less than or equal to 12 months.
Such an asset will have well defined credit weaknesses that jeopardise the liquidation of the debt and are characterized by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.
An asset would be classified as doubtful if it has remained in the substandard category for a period of more than 12 months.
A loan classified as doubtful has all the weaknesses inherent in assets that were classified as sub-standard, with the added characteristic that the weaknesses make collection or liquidation in full, – on the basis of currently known facts, conditions and values – highly questionable and improbable.
A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.
|Asset type||Criterion to be qualified as:|
|Standard Asset||Doesn’t disclose any problems and which does not carry more than normal risk.|
|Non-Performing Asset||Not returning in the form of principal or interest in the last 90 reporting days.|
|Substandard Asset||Remained NPA for a period less than or equal to 12 months.|
|Doubtful Asset||Remains as substandard category for a period of more than 12 months.|
|Loss Asset||Loss identified by the bank/internal/external auditors/RBI inspection, but the amount has not been written off wholly.|
Loss assets should be written off. If loss assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for. This means that full amount of the loss assets should be kept from some other sources like profit of the bank to meet the loss.
The mechanism of Provisioning is done to address the asset quality deterioration for a bank’s assets. The worse is the assets’ quality; higher will be the provisioning coverage ratio. Banks should make provision against substandard assets, doubtful assets and loss assets in a differential manner.