Understanding what are NPA’s or Non-Performing Assets: While evaluating banking sector companies, one of the key aspects that every investor needs to check is its NPA. In this article, we are going to discuss what are NPA’s, How NPA’s are categorized, How do these NPA’s affect the banks, and the reasons for high NPA’s in India. Let’s get started.

What are NPA’s?

Loans and advances that are given by the bank require the borrower to make payments in the form of installments that include the principal and interest amounts. At times the borrowers miss out on these installments, either due to lack of funds or at times willfully. When the principal or interest payments are missed and remain due for over 90 days the loans are classified as NPA’s.

Categorization of NPA’s

Banks then further classify these loans categorized as NPA’s on the basis of time i.e. on the length of non-payment of the loans. This further classification helps banks judge the possibility of recovering the loans with interest. Further classifications are done as follows 

1. Standard Assets

Standard Assets are loans that have remained as NPA’s for a period of 12 months or less. The risk associated with Standard Assets is low as the possibility of repayment still remains.

2. Sub-standard Assets

Sub Standard Assets are loans that have remained as NPA’s for a period of 12 months or less. Here the risk associated with the nonpayment of the loan is increased in comparison to Standard assets.

3. Doubtful Debts

Loans classified as NPA’s that are classified as NPA’s for a period exceeding 18 months are known as Doubtful Debts. The probability of loan recovery from these NPA’s is extremely low. Banks that have high NPA’s with the majority exceeding 18 months are affected with reduced liquidity.

In addition to this, the banks also suffer a loss to their reputation as the banks are held responsible to verify the creditworthiness of the borrowers before giving away loans. This shows poor management and poor judgment on the part of the banks.

4. Loss Assets

NPA’s that are identified by auditors to be non-collectible or recoverable is classified as NPA. At times banks look at the possibility of salvaging the collaterals placed but if that does not happen the loss assets dent the Balance Sheets. The Banks will have to further create provisions where a portion of the profits are transferred in order to writeoff the assets.

Gross vs. Net NPA’s

NPA’s are also classified as gross or net NPA’s. Gross NPA’s include both the principal and interest aspects of the loan classifies as NPA. Net NPA is arrived at when the principal amount is deducted by any payments received by the bank from the borrower with respect to the loan and also includes the amount the bank receives through its insurance claims or provisions set for the loan.

I.e Net NPA = Loan Amount – [Interest payments received + Insurance (DICGC & DCGC) + provisions made if any]

How do these NPA’s affect the banks?

A balance sheet that has a high percentage of NPA’s immediately impacts the banks’ cash flow and future earnings. Firstly if these NPA’s if paid on time would’ve generated added capital to the banks which, in turn, could be used to by the banks to extend further loans. In addition to the reduced ability to generate profits the bank also has to create provisions in order to set off the loss due to NPA’s. This provision will be sourced from the future profits of the bank which otherwise could have been used to maintain stable growth.

What do high NPA’s mean to other stakeholders?

The best example to assess the effect of NPA’s on stakeholders will be that of ‘Yes Bank’. The high NPA’s will have a significant impact on its customers where all withdrawals available to customers were capped at Rs. 50,000. This impacted many businesses as surviving on a cash flow simply would not even cover employee expenditures of the respective business. 

NPA’s are also an important aspect when it comes to investment decisions. High NPA’s are a red flag that the investments in that particular bank are not viable. The shares of Yes Bank suffered an 85% downfall after the news of their poor financials broke out.

Also read: The Unravelling of Yes Bank – Fiasco Explained

India’s position with regards to NPA(Source: Moneycontrol)

Indias NPA’s stood at 9.1% as of March 2019. Although there was a decline from 14.7% in the previous years there was little to rejoice about. This is because according to data if a bank provides loans that it can be expected that they may not be repaid as high as 9% of the total loans given.

The NPA situation, however, has rarely improved in India. As of 2017, there were only 4 countries with worse NPA’s than India. These countries were infamously known as PIIGS in Europe due to their NPA’s. They included Portugal, Italy, Ireland, Greece, and Spain. It is noteworthy that Spain’s NPA stood lower than India at 5.28%.

What are the reasons for high NPA’s in India?

(Source)

A) Economic: The Indian Economy enjoyed a boom phase from 2000-2008 where banks started lending extensively to companies in the hopes that the boom phase last where everyone benefits. However, the 2008 financial crisis hit the economy hard and gravely affected corporate profits.

This further affected the NPA’s during the recession. It was also around the period when the government banned mining projects affecting the infrastructure sector. Hence it can be observed that the majority of the NPA’s are formed by power, iron, steel, and construction companies.

B) Negligence and Corruption: The negligence of banks in assessing the creditworthiness is a major reason for increasing NPA’s. This is normally seen in cases where big corporates are involved. Then comes the problem of corruption when where loans are made available to corporates even when they have poor financials and credit ratings.

The best case study present here has been the case of Vijay Mallya. Loans were given to Kingfisher by BOI on Current Assets like office stationery, boarding pass printers, and folding chairs placed as collateral. 

Also read: Demystifying Vijay Mallya Scam

Bottomline

Current times also show instances why it is important to have good NPA’s. Banks that do are able to weather a financial crisis better. Indian banks that already suffer from poor NPA’s now face a struggle to survive the COVID-19 environment. Rating agency CARE has estimated that the Gross NPA’s of Indian banks are likely to rise to 9.6-9.9%, compared to the December quarter of last year where it stood at 9.3%. Experts, however, believe that they are to rise significantly more than that.

Due to the economic slowdown, one may expect banks to provide lesser loans at high rates as they may not see viable investments. But this is not what happens. In order to restart the economy, it is very important that the banks provide capital to ailing and new businesses. This has now put the banks in a pickle where they already suffer poor health and now they have had to go ahead and provide a moratorium on existing loan payments and added loans to help businesses survive.

Aron Almeida

Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.