While dealing with borrowing or lending with a third party, it is crucial to know what NPA is in banking. This helps identify how to deal with assets with unpaid dues, where they are classified, and how they affect the borrower and lender.
What is a non-performing asset?
For starters, let’s answer the question ofwhat is the full form of NPA in the banking sector. These are non-performing assets. Financial institutions often use them as a classification for loans and other advancements.
However, only those loans or advancements are taken into account on which the principal is past due and interest payments have yet to be made for a set period. A loan may become an NPA if it has an outstanding amount that has lasted 90 days or more. However, it is essential to note that some lenders might use a shorter period while determining when an advance or loan is past due.
To clarify what is meant by NPA in banking, let’s consider a situation when a borrower has stopped repaying a loan; it can be classified as a non-performing asset. As a result, the bank or other lender can only generate income if there is an inflow from the borrower. In a case of this nature, the loan is now considered “in arrears”.
Subdivisions of a non-performing asset
Before classifying an asset as non-performing, most lenders or banks offer a grace period. After this time has passed, it is considered an NPA. This can be in any of the following sub-classifications:
- Standard assets
Any NPAs that have not been paid from 90 days to 12 months with an average risk level are placed into this category.
- Sub-standard assets
Any NPAs due for over 12 months are classified as sub-standard ones. The risk level of these assets is much higher, especially if the borrower has credit below the ideal amount. In most cases, banks assign a reduction in the market value known as a “haircut” to these NPAs. This is because they are less confident that the entire amount will eventually be repaid.
- Doubtful debts
If an asset has not been paid for at least 18 months, it is placed in this category. These usually indicate that a bank has severe doubts about whether the borrower will repay the entire loan at any point, which seriously negatively affects the lender’s risk profile.
- Loss assets
A non-performing asset is considered a loss when it has a long period of unpaid dues. Banks or lenders are forced to accept that the loan will never be repaid, so when an NPA is in this class, it must be recorded as a loss on the balance sheet. As a result, the entire amount of the loan must be written off.
By understanding these types, you no longer have to ask what is the meaning of NPA in banking.
How do NPAs work?
To reiterate what NPAs in the banking sector are, they are loans that are not transferred into an NPA class until a specific period has passed, during which no payment has been received. However, since several factors could lead to a late interest and principal amount on the borrower’s end, an extended grace period is often offered.
Banks usually classify a loan as overdue after a month or so. However, it is converted into a non-performing asset only after the end of the grace period. This is often after 90 days of non-payment.
To collect outstanding debt, lenders often foreclose on whatever asset or property has been declared to obtain the loan initially. For example, assume that the borrower decided to take out a second mortgage, and it becomes an NPA. After this, the bank usually sends a notice of foreclosure on the home, which was used as collateral for the loan.
Significance of NPAs
Now that you know in general terms what the meaning of NPA in banking is, let’s delve into its significance. Both parties performing in the loan must be aware of the performing and non-performing assets. For example, if the borrower is dealing with a non-performing one and interest payments are unpaid, their credit and, thus, possibilities for growth can be negatively affected. This can affect their ability to obtain loans in the future as well.
On the other hand, the interest earned on loans is the primary source of income for lenders. This could cause non-performing assets to negatively affect their ability to obtain income, lowering their overall profit. Banks must keep track of all NPAs to prevent too many of them from surfacing and affecting their growth and liquidity abilities.
Although it is possible to manage NPAs, it depends on the number and the time that has passed since they have been due. So, most banks have the capacity to deal with a decent number of NPAs. However, if the lender consistently takes on more non-performing assets and the quantity increases significantly over time, the financial health and future success can be negatively affected.
Third-party lenders, however, might not be able to deal with NPAs, so one should be aware of their capacity to hold them without negatively affecting their revenue stream.
We hope this article has helped you understand what non-performing assets are and why they are needed. If you are an investor from India, you can get more information about what is the meaning of NPA in the banking sector by using resources in Hindi or Marathi. And those who want to delve even deeper into the financial analysis are recommended to learn accounting basics and how to read financial statements.