Why does NPA Continue to be a Sore for Banking Industry?

A non-performing asset (NPA) is a loan or credit that has gone into default or is overdue because the principal or interest repayment has lapsed for more than 90 days. NPAs either bring in revenue or provide some other benefit to individuals, businesses, and governments. However, banks classify any financial instruments they own or whatever the borrower owns as an asset. There are many reasons for the increase of NPA in the banking sector, Mismatched Expectations being one of them. Large initiatives are occasionally set up by overoptimistic promoters with great returns in mind. However, profits are not as large as promised due to poor and volatile market conditions, leaving lenders stranded with unfinished large projects.

Put another way, NPAs are loans where the interest has been late or not paid at all. These are also the types of loans in which the lender believes the loan agreement has been broken and the borrower is unable to repay the debt.

Why are NPAs a Sore for the Banking Industry?

Banks give loans to both business and retail clients. NPAs are an important metric for assessing a bank’s performance and financial health. The amount of nonperforming assets (NPAs) is one factor that influences the banking sector’s financial stability and growth.

Below are the main reasons why there is a rise in NPAs in the Indian Banking Industry:

• Mismatched Expectations:

Overoptimistic promoters periodically launch large initiatives with high expectations. However, profits are not as high as expected due to dismal and volatile market conditions, leaving lenders with incomplete large projects.

• Lack of Coordination:

The lack of cooperation between banks and financial organisations is frequently mentioned. Funding long-term transactions with short-term loans are a financing mismatch. NPAs arise as a result of this disparity.

• Political, Social and Financial Pressures:

PSU banks frequently operate under the auspices of the government and its agencies. NPA debtors are sometimes unable to compete with reduced costs and more options available to consumers. Interest rates are often extremely high. All these factors contribute to increased NPAs.

• Lack of Transperancy:

In the banking sector, there is a lack of openness and accountability. The auditing procedures are inadequate and ineffective.

Causes of NPA in the Banking Industry:

Factors affecting the banking industry are divided into internal and external factors.

I) Internal Factors:

• Finances borrowed for a specific purpose are not used for that purpose
• Inadequate lending process: Commercial banks adhere to three principles – the principle of liquidity, the principle of profitability, and the principle of safety
• Inadequate technology: Market-driven real-time decisions are impossible to make due to insufficient technical and management information systems
• Bank branches should upgrade all systems to reflect the current situation
• Incorrect SWOT analysis: Another cause of the rise in NPAs is an incorrect strength, weakness, opportunity, and threat analysis
• Thus, the bank should consider profitability, viability, and long-term acceptability while financing a project
• Poor credit appraisal system: The bank provides advances to those who are unable to repay them due to poor credit appraisal
• As a result, there is a rise in the bank’s NPAs
• Managerial flaws: The banking should always choose the borrower with caution and use actual assets as collateral to protect its interests
• The lender should adhere to the risk diversification principle, which means that the banker should not limit advances to a few large companies or a few industries or cities

II) External Factors

• Ineffective recovery tribunals: The government has established several recovery tribunals to assist in the recovery of loans and advances
• However, due to their inattentiveness and inefficient work, the bank suffers the consequences of non-recovery, thereby reducing profitability and liquidity
• Natural disasters: This is the determining factor causing an alarming rise in NPAs
• Our farmers rely on rainfall for cropping, but due to unpredictable weather changes, they are unable to meet production targets and are unable to repay their loans
• Thus, banks need to set aside substantial money to repay these debts
• Inappropriate project management, ineffective management, a lack of adequate resources, a lack of advanced technology, and day-to-day changes in government policies all contribute to industrial sickness, resulting in low loan recovery and a reduction in profit and liquidity for the banks that fund those industries
• Willful Defaults: These defaults are wreaking havoc on India’s public sector banks
• It’s a failure to meet a repayment commitment
• Our farmers rely on rainfall for crops, but due to erratic rainfall, they are unable to meet their production targets and cannot repay their debts
• As a result, banks must set aside a significant amount of money to repay those loans

Effects of NPAs on Banks:

The following are the effects of rising NPAs on  banks:

• Bank profitability is low
• The credibility of the bank is harmed
• A reduction in fund recycling hampers the banks’ ability to lend money
• Shareholders’ belief is shaken
• Increases the value of risk-weighted assets
• Banks cut interest rates on deposits and raise interest rates on advances to maintain net interest margin, thereby stifling growth
• As the banking industry continues to suffer from nonperforming assets (NPAs), it is necessary to adopt and implement remedial actions to reduce NPAs

Conclusion:

When a bank does not receive payment of the principal and interest on a loan for more than three months, the loan is categorised as NPA. The interest received by the banks on the loans granted to the borrowers is how they make money. The bank uses this money to pay interest to depositors. The difference between interest income and income paid is the bank’s profit. This is the reason why a bank’s interest rate is always higher than the interest rate paid to depositors.