Short Note on NPA : ( Non-Performing Assets )

Today’s piece focuses on NPAs and Asset Classification. Every banker worth his salt should have the basic knowledge of the second most important aspect of banking – giving loans and then whatever happens when a loan turns bad!!

Why second most important? ‘Cause accepting deposits is the most important function of banks! If you don't have the money, how will you give the loans?

I’m gonna straight away start with NPAs and not waste any of our precious study time!  Happy Reading :)

1. What are NPAs?

NPA stands for Non-Performing Assets. Loans given by Banks are its assets. Banks have the right to receive the amount back from the loan taker – right? – thus, ‘Loans and Advances’ given by banks are their assets.

When such asset does not perform it becomes an NPA. Simple enough?!

2. What is meant by loans/assets not performing?

When we talk from a Bank’s point of view, what is a loan account supposed to do?

It is supposed to given the Bank regular instalments of principal and interest on such principal. Thus for a Bank, a loan account is ‘functioning’ or ‘performing’ its required task when it is regularly receiving credits of the instalment amounts.

When the credits stop – i.e., when the customer stops paying instalments – the loan account stops ‘functioning or performing’.

3. And when does it become an NPA?

Such a non-performing loan account is ‘officially’ denoted or classified as NPA when the account has remained non-performing for a period of more than 90 days.

That is the loan account has not received any credit towards instalment (interest and/or principal) for more than 90 days – which automatically means – the interest/principal is OVERDUE for a period more than 90 days.

Guys, please note and remember the phrase, ‘overdue for a period more than 90 days’ – important to appreciate the word ‘overdue’.

When you get October month’s telephone bill (which you have to pay by 1st December 2014) in the first week of November, the amount is said to be due. When that amount of October month’s telephone bill is still unpaid till January 2015 it is said to be overdue! 

Same way - when instalment is ‘overdue’ only then do the Banks classifies them as NPAs. They give time till 90 days and wait and watch and even hope that the customer pays something – and when 90 days are up the account becomes an NPA automatically.

So – overdue for more than 90 days.

4. Why do the Banks ‘hope’ for the customer to pay back?

Because, any asset becoming bad is the asset owner’s loss, right?

Thus if a loan account goes bad – defunct – NPA – it is the Bank’s loss! 

And trust me the officers in charge of the loans and advances and the branch managers lose a lot of hair when audit season comes and they have to deal with large NPAs – not a good sight!

5. What happens when accounts become NPA?

First – it is the starting sign that things could get worse – I’ll explain in the next point!

Bookishly though – the implications of an account being classified as an NPA are these:

(i) Banks cannot credit income to their profit and loss account in with corresponding debit of the NPA loan account unless any recovery takes place.

Bank’s income is the ‘interest amount’ it receives on loans – and Banks practice charging interest to the loan account and crediting their Profit and Loss account when the interest becomes ‘due’. Since the loan account has become NPA, now the Banks cannot ‘due’ anymore interest charges.

Sort of like, after being classified as an NPA, the telephone company cannot send the customer anymore bills for due amount!

But if the customer pays ‘any amount’, i.e., after the loan amount becoming NPA, if the customer pays any amount to its credit – then such an amount can be taken as an income for the bank and credited to its P & L A/c.

(ii) Provision will have to be made – which reduces the banks profits.

Banking norms mandate that when there is possibility that loss can happen in future, provision for the loss is to be made in the present.

Think – if you had a child who’s very intelligent and ambitious and wants to go to USA to become an astronaut in future – you will needs funds when the time comes.

So you start putting some money aside/provisioning for the future NASA astronaut from today – which means your saving/the real income is getting less today, because you made a provision for an expense/loss you think will most definitely happen in the future!

Same thing, the Banks now know that the customer has not paid for more than 90 days now – but what if the customer does not pay at all and the outstanding amount is Rs.10,00,000!

It’s a Rs.10,00,000 loss to the Bank in the future!

And according to provisioning norms, the Banks will have to create a provision for this ‘possible loss’ and provision is made against income (try to understand with the NASA example). 

So this would mean that a Bank’s profits will become less due to the heavy provisioning on NPA accounts.

And when profits decrease – loan officers/ branch manager/ regional managers/ zonal managers all face the heat from GMs/AGMs/DGMs/MDs and the shareholders and the stock markets! Phew!

(iii) All the loan accounts of the same customer, in the other branches of the same bank will be classified as NPAs too (even if they are regular and instalments are being credited to them!)

Too bad, huh?

Imagine if a customer has loan accounts in 5 branches of the same bank and all are over crores – that is the real life scenario – ‘cause businesses take large loans. The bank gets NPAs in all those 5 accounts!

And there are many such customers!