17 Mar 2022
Assets are of many kinds, such as performing assets, non-performing assets, current assets, non-current assets, tangible assets, intangible assets, standard assets, etc. In this article, we will discuss the concept of non-performing assets in the banking sector. Non-performing assets (NPA) refer to defaulted or outstanding loans or advances exceeding ninety days. An asset is considered non-performing when it does not generate income for the bank. Such non-performing assets are recorded in the balance sheet of the bank if not paid by the borrower for a long time. In case of non-payment of due sum, the lender bank takes steps to liquidate the borrower’s assets, which he kept as a pledge at the time of that debt agreement. If there are no assets pledged, the bank writes off such debt as a bad debt, and the bank sells it at a discounted rate to a collection agency. The standard time for considering a non-payment of a loan as non-performing assets is 90 days, but the outstanding period could be shorter or longer depending on the particular loan terms and conditions. It can be declared non-performing at any time at any stage of the loan. Non-performing assets put a burden on banks, and if the number of NPAs keeps increasing, this would put the bank in a massive financial crisis and be a reason for the bank’s collapse due to irreparable loss. Non-performing assets other than loans are listed below:
- Cash Credit and Overdraft: Kind of non-performing assets where accounts remain out-of-order or overdue for more than 90 days declared as non-performing assets.
- Agricultural advances: The interest or principal installment payments remain overdue for two crop/harvest seasons for short-duration crops or overdue one crop season for long-duration crops of agricultural advances.
- Term Loans: Scheduled payment on any other type of account is outstanding for more than 90 days.
Banks classify the non-performing assets as follows:
- Standard Assets: These are the types of assets that have remained outstanding for 12 months or less than 12 months. The risk factor of non-performing assets is normal.
- Sub-Standard Assets: The assets remain as non-performing assets for less than or equal to the period of 12 months; they are referred to as sub-standard assets. The risk of losing advance is not normal in such a case.
- Doubtful Debts/Assets: The assets that remain non-performing for a period of more than 12 months remain as sub-standard assets are considered doubtful debts. It is evident from its name that the bank is highly doubtful of the recovery of its advances.
- Loss Assets: This is the non-performing asset, where the bank itself or external auditors identify that collecting a loan is not possible, and the bank writes off the whole amount of loans as outstanding or overdue in its balance sheet.
In the past few years, banks face challenges regarding loans and the non-payment of loans, which overburdens banks to stabilize their business. There are various reasons for this increase of non-performing assets, such as banks do not enquire much about the financial status of borrowers; this creates troubles later on in the form of non-payment of loan principal or interest. Another reason is customers do not perform the business they have taken a loan for, and they most often face loss in such cases and fail to pay loans back. Some fraudsters, out of habit, take a loan and do not return loan principal or interest, which creates enormous pressures on the bank’s financial health. Furthermore, governments change policies for loan payments or waive payments of loans for some categories and sanction loans for agriculture or any other specific purpose putting banks in a dark alley by becoming a reason for banks’ non-performing assets. The non-payment of the loan’s interest or principal can badly affect the banks’ cash flow, which will result in a decrease of budgets for subsequent loans in the future and reduce the profits of banks.
Generally, banks set aside loan loss provisions to avoid massive loss due to non-payment of loans and increase in non-performing assets and cope with the crucial financial crisis that emerged due to defaults in loan payments. Banks can recover losses from non-performing assets somehow; there are four options with the lenders/banks to recover losses in whole or some parts of the loan.
- Firstly, banks can take timely actions to restructure loans to avoid non-performing assets and make the borrower pay back the loan.
- Secondly, when taking a loan, borrowers pledge any collateral to ensure the bank that they will return the loan amount. When the borrower defaults in payment of the loan, the bank can take possession of such collateral and recover its loss by selling it.
- Thirdly, when a loan defaults, the bank can sell/convert that bad debt into equity to recover the loan’s principal amount.
- Lastly, if no option remains with the bank to recover losses due to non-performing assets, it sells the bad debt to loan collecting companies at a lesser price than the loan principal’s merit to avoid a complete loss.
Banks are the backbone of any country’s economy, and they need to be more vigilant in the matters of lending loans. Banks need to reduce NPAs to get stable. Before lending loans to borrowers, a bank should bear in mind the borrower’s character to judge his willingness to return a loan. The collateral he has pledged for obtaining a loan should be appropriately assessed, and the condition and capacity of the borrowing company should also be assessed to ensure its capacity to return the loan within the stipulated term and also seek legal advice from banking lawyers.