Non-Performing Assets

You’ve undoubtedly understood that the loans a bank makes are its assets. So, if either the principal or the interest on loans are never paid back to the lender (bank), the debt is considered a “Non-Performing Asset” (NPA). Non-Performing Asset (NPA) refers to an investment that has ceased to generate profits for its owners for an extended period. Most governments and financial institutions impose this time limit at 90 days. These terms and conditions are open to negotiation between the lender and the borrower and are not intended to be rigid rules that must be followed. The Reserve Bank of India describes non-performing assets (NPAs) as loans that are unpaid for more than 90 days. 

How Severe is the Loan Never Paid Back Problem?

• There are still around Rs 6 trillion NPAs at the end of 2021 compared to Rs 7 trillion in 2019
• This is a significant quantity of money, no question.
• The amount is approximately comparable to about 10 percent of all loans.
• This suggests that around 10 percent of loans are never paid back, which costs the banks a lot of money.
• 15–20 percent of all loans would be under stress if restructured and unrecognised assets were included.
• In absence of any policy changes, the country’s NPA problem could become worse.
• Norms for restructuring are being broken.
• As in the case of the US subprime crisis of 2008, this bad performance is not a good indication and may lead to bank collapses, impacting the economy.
• Also, India’s NPA condition is worse than that of the other emerging economies in the BRICS group.

What are the Causes of NPAs?

• Businesses diversifying financial resources among several unrelated businesses or projects or committing fraud or other similar malpractices.
• Failures as a result of not following proper policies or procedures.
• Abrupt changes in the business environment, or in the laws and regulations and a company’s inability to adapt could cause losses.
• Low morale, especially after the government steps to rescue businesses and reduce debts.
• Firms see their revenues and profit margins collapse from global, regional, or national financial crises. This puts pressure on their balance sheets, which means they can’t meet their interest and loan payments. (Like the global financial crisis of 2008)
• A general economic downturn could also contribute to missed payments and increase non-payments. NPAs increased in India, for example, when the country’s economy stagnated in 2011.
• Due to the downturn, certain companies in a given sector may be forced to close their doors.
• During the boom, businesses expanded without planning, and low-interest loans were eventually repaid at exorbitant rates, resulting in non performing assets (NPAs).
• Inadequate company management, such as defaulters who purposefully fail to pay.
• Inefficient management and policy paralysis cause projects to stall and fail, leading to NPAs. Eg., the Infrastructure Sector.
• There is a lot of competitiveness in every market segment, but very intense competition can lead firms to collapse and increase the NPAs. Eg., the Indian telecoms industry.
• When loans are issued with terms and conditions that are not clear to the borrower, they become unable to repay.
• Many natural calamities, such as flooding, drought and a wide range of infectious diseases, have resulted in huge losses for businesses and people.

What is the Impact of Bad Loans?

• Lenders’ profit margins shrink bringing the capital adequacy into question.
• There is less money available to fund other projects when the banking sector is stretched, which is harmful to the economy as a whole.
• Banks have to hike interest rates so they can keep making money, making debt servicing more costly.
• As investments could be locked, due to investors being overly cautious, it may cause people to lose their job.
• Investors in public sector banks suffer when the banks perform poorly, resulting in smaller dividend payments to the Indian government. Increased funding challenges for social services and infrastructure might have severe consequences for society and the democratic system.
• Investors get lower or no returns on their investments.
• Balance sheet syndrome in India suggests that both banks and corporations have stressed balance sheets, which hampers the investment-led development process.
• Matters involving NPAs add to the burden of cases that are now before the courts at various levels.

Conclusion

Currently, dealing with NPAs necessitates quick and strong measures. This should include leveraging technology and data analytics to identify early warning flags. Criteria must be set to identify any hidden NPAs. Methods of evaluating credit must be continually developed to proactively include factors as they come into play, rather than waiting for an issue. Further, the scope of forensic audits can be widened to understand the borrower’s intent.