Introduction to Non Performing Assets
The main revenue source for banks is giving loans and advances. When the payments from the loans and advances either default or are late, then that is called Non Performing assets. Non Performing assets are bad for banks or institutions. Non Performing Assets portray a bad financial picture of the bank.
There are different rules by different countries regarding the recording of Non Performing assets. Generally, there is a certain stipulated period, after which an asset is recorded as Non-Performing. Banks are strictly regulated by governing bodies as they deal with public money, so if Non-performing asset increases at an alarming rate, then it triggers the regulators to take strict action against the management of the bank.
How does it Work?
Non Performing assets are kept in the balance sheet for a stipulated amount of time. The time period is determined by the governing body and as per accounting standards. When the time period is over, then the lender will either liquidate the assets that are kept as collateral or write-off the asset as bad debt. There are third party agencies, which are specialised in recovering bad debts. They buy bad debts from banks at steep discounts and then start to recover the money.
Example of Non Performing Assets
Corporation Bank gave house loan to Mr X of $100,000. The house was kept as mortgaged. The loan was for 30 years and the monthly instalment was $300. Mr X paid instalments properly for 2 years and after that due to financial issues, he stopped paying instalments. Corporation bank started sending recovery mails to Mr X from the next month onwards. After the stipulated time, when corporation bank realised that Mr X will not be paying the instalments further, they marked the asset as Non-Performing asset. As the loan was collateralised with the house, so the corporation bank will sell the house now in order to recover the loan money.
Types of Non Performing Assets
- Fixed Maturity loans. The most common type of loans that are marked as NPA is a personal loan with a fixed maturity. As personal loans are mostly issued without collateral, so default in payments lead to writing-off of the loan from the balance sheet.
- Mortgaged Loans. Mainly house loans are issued for long maturities. The maturity ranges from 25years to 30 years. As the term is long, so chances of default is also high. As the loan is collateralised, so as soon as the loan turns bad, the bank sells the collateral to recover the amount.
- Credit card defaults are also part of Non Performing Assets. As credit cards are issued without any collateral, so recovery rate is very low. Once the asset turns Non-Performing, it gets difficult to recover. Mainly the duration of credit card default or overdraft is 90 days. The institution sees whether money is recovered within 90 days.
- Agricultural loans are estimated using the harvesting period. Most of the farmers take loan in order to grow crops. If the cultivation is not as per expectation, then the farmers fail to pay-off the loan. There is stipulated time period, after which the lender marks the loan as NPA
Reasons for Non Performing Assets
- In case of house loan, if the price of a house in the market decreases, then the borrower will not be willing to repay the debt of the house, as he can buy another house from the market at a cheaper rate.
- If a borrower is not planning to pay off the debt at his own will. This is termed as a wilful defaulter. Though the financial condition of the borrower is stable, still he is not planning to pay off the debt
- If the economy gets into depression, then it gets difficult for borrowers to earn money in order to pay off the debt.
- The poor screening process of the lender. If the lender doesn’t validate the financial position of the borrower thoroughly before giving the loan, then chances of default are more.
- If the recovery channel of the lender is not effective, then the borrowers will tend to default more. There should be a tight recovery schedule.
Impact of Non Performing Assets
If the NPA of an institution is higher than the market average rate, then it creates a negative impact on the institution. The credit rating agencies tend to give lower credit ratings as the chances of default increases. Investors lose confidence on the institution and start to sell off the stocks. As the chances of bankruptcy increases, so the institution will have to offer greater interest in order to lend money for expansion. Regulators start to monitor each movement of the bank very closely as public money in the form of deposit is involved.
The default of a bank or institution due to NPA will affect the whole economy as billions of dollars will be lost. The whole economy will take the hit.
Significance of NPA
NPA is an extremely important indicator to judge the performance of a bank or institution. A good institution will have a lower NPA to total asset ratio. This shows the quality of the financial position of a bank or institution. NPA is an extremely important parameter and is being considered as a guiding principle by several credit rating agencies, research companies and regulatory bodies.
Benefits of NPA
- NPA accounting helps lenders to estimate the total assets which are not performing well and needs special attention. This is the data that help the Board of Directors to organise meetings and discuss with the management.
- Too much of NPA triggers government that the economy is going towards recession and needs support in order to recover. So it acts as an indicator.
Conclusion
NPA shows the financial condition of an institution or bank. Lenders should follow a well-organised mechanism for loan approval. Too much of NPA will hurt the balance sheet of the lender and will make it difficult for them to survive in the market.
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