A strong banking sector is essential for flourishing economy. The failure of the banking sector may have an adverse impact on other sectors, so, Non-performing assets are one of the major concerns for banks in India.
When loans are made by a bank or finance company, on which repayments or interest payments are not being made on time, these loans are called as Non-performing assets or non-performing loans. Non Performing Asset means an asset or account of borrower, which has been classified by a bank or financial institution as sub-standard, unsure or loss asset, in accordance with the instructions or guidelines relating to asset classification issued by The Reserve Bank of India. NPAs reflect the performance of banks; a high level of NPAs suggests high probability of a large number of credit defaults that affect the profitability and net-worth of banks and also erodes the value of the asset. The NPA growth involves the requirement of provisions, which reduces the over all profits and shareholders value.
A loan is an asset for a bank as the interest payments and the repayment of the principal create a flow of cash flows; it is from the interest payments than a bank makes its profits.
Banks generally treat assets as non-performing if they are not serviced for some time, if payments are late for a short time a loan is classified as past due. Once a payment becomes actually late the loan classified as non-performing.
Thirty days past due:
A sum due under any credit facility is treated as "past due" when it has not been paid within 30 days from the due date. Due to the development in the payment and settlement systems, recovery climate, up gradation of technology in the banking system, etc., it was decided to dispense with 'past due' concept, with effect from March 31, 2001. Hence, as from that date, a Non performing asset (NPA) shall be an advance where:
1. Interest or installment of principal remain overdue for a period in excess of 180 days in respect of a Term Loan,
2. The account remains 'out of order' for a period of above 180 days, in respect of an overdraft/ cash Credit,
3. The bill remains overdue for a period in excess of 180 days in the case of bills purchased and discounted,
4. Interest or installment of principal remains overdue for two harvest seasons but for a period not more than two half years in the case of an advance granted for agricultural purpose, and
5. Any amount to be received remains overdue for a period in excess of 180 days in respect of other accounts.
Ninety days overdue
With a view to moving towards international best practices and to ensure greater transparency, it has been determined to adopt the '90 days overdue' norm for identification of NPAs, from the year ending March 31, 2004. Therefore, with effect form March 31, 2004, a non-performing asset (NPA) is a loan or an advance where:
1. Interest or installment of principal remain overdue for a period in excess of 90 days in respect of a Term Loan,
2. The account remains 'out of order' for a period in excess of 90 days, in respect of an overdraft/ cash Credit,
3. The bill remains overdue for a period in excess of 90 days in the case of bills purchased and discounted,
4. Interest or installment of principal remains overdue for two harvest seasons but for a period not more than two and half years in the case of an advance granted for agricultural purpose, and
5. Any amount to be received remains overdue for a period in excess of 90 days in respect of other
Out of order
An account should be treated as 'out of order' if the outstanding balance remains constantly in excess of the sanctioned limit/ drawing power. In case where the outstanding balance in the principal operating account is below the sanctioned limit/ drawing power, but there are no credits continuously for six months as on the date of balance sheet or credits are not enough to cover the interest debited during the same period, these account should be treated as 'out of order'.
Say the due date for any payment is 4th of September 2008 but the customer is not paying the sum by this date, this amount will be shown as overdue .
Many institutions now try to sell their non-performing assets through companies like KIM-LAR, INC, which facilitate the sale of these bundled portfolios. The non-performing assets include mortgage loans, car loans, credit card debt and installment loans.
A high level of non-performing assets compared to related lenders may be an indication of problems, as may a sudden increase. Still this needs to be looked at in the context of the type of lending being done. A few banks lend to higher risk customers than others and so tend to have a higher proportion of non-performing debt, but will make up for this by charging borrowers higher interest rates, increasing spreads. A mortgage lender will almost certainly have smaller non-performing assets than a credit card specialist, but the latter will have higher spreads and may well make a bigger profit on the same assets, even if it eventually has to write off the non-performing loans.
The matter of Non Performing Assets has been discussed at length for financial system all over the world. The difficulty of NPAs is not only affecting the banks but also the whole economy. In fact high level of NPAs in Indian banks is nothing but an indication of the state of health of the industry and trade.