What are the Non-Performing Assets (NPA)?

Non-performing assets (NPA) refer to the classification of loans and advances in the books of a lender (usually banks) in which there is no payment of interest and principal has been received and is “past due.” In most cases, debt has been classified as NPAs where the loan payments have been outstanding for more than 90 days.

  • NPA is generally classified on the bank’s balance sheet, and the percentage of NPA out of the total advances becomes a vital ratio for the banks to check before making the results public.More than 90 days where payment is due to the banks’ loans and advances move to NPA.In the term sheetIn The Term SheetA term sheet is an agreement facilitating a fundraising process whereby two parties mutually agree to abide by the mentioned clauses concerning the investment.read more/sanction letter, the period of default under which the loan will be classified as non-performing assets are generally mentioned.As noted above, Bank of America has an NPA of around $4,170 million accrued for 90 days or more.

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Key Takeaways

  • NPA or non-performing assets refers to outstanding loans and advances in which the borrower fails to pay principal and interest payments to the lender for more than 90 days. In such cases, the lender considers the loan ‘in default’ and classifies it as an NPA in the balance sheet of the financial year. Banks classify non-performing assets (NPA) into four groups: Standard Assets, Sub-Standard Assets, Doubtful Debts, and Loss Assets.Before making any loan advances, banks must remember the 4 C’s: Character, Collateral, Capacity, and Condition. Big credit firms analyze any company in the 4 C parameter.Banks must check the NPA percentage before publicizing the results.

Non-Performing Assets (NPA) Example

For example, the company XYZ has taken a loan of $100 million from the bank ADCB and needs to pay $10,000 of interest every month for five years. If the borrower defaults on the payment for three consecutive months, i.e., 90 days, the bank needs to classify the loan as a non-performing asset on their balance sheet for that financial yearBalance Sheet For That Financial YearA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more.

Types of Non-Performing Assets (NPA)

#1 – Term Loans

A term loan, i.e., a plain vanilla debt facility, is treated as an NPA when the principal or the interest installment of the loan has been due for more than 90 days.

#2 – Cash Credit and Overdraft

Cash credit or a remaining overdraftOverdraftOverdraft is a banking facility that offers short-term credit to the account holders by allowing them to withdraw money from their savings or current account even if their account balance is or below zero. Its authorized limit differs from customer to customer.read more past due for more than 90 days can be treated as an NPA.

#3 – Agricultural Advances

Agricultural advances that have been past due for more than two crop seasons for short crop duration or one crop duration for long duration crops.

There could be other types of NPAs, including residential mortgages, home equity loans, credit cardCardWhen a normal credit card is issued after providing a sufficient security deposit, it is called a secured credit card. It is given to individuals lacking credit scores in the market. In contrast, unsecured credit cards are given to those customers with fair credit and a good image.read more loans, non-credit card outstandings, and direct and indirect consumer loansConsumer LoansA consumer loan is a type of credit given to a consumer to finance specified set of expenditures. The borrower must pledge a specific asset as collateral for the loan, or it may be unsecured depending on the loan’s monetary value.read more.

Classification of NPA for Banks

Banks classify the non-performing assets (NPA) into the following type four groups: –

#1 – Standard Assets

Standard assets are those assets that have remained NPA for 12 months or less than 12 months, and the risk of the asset is normal

#2 – Sub- Standard Assets

For more than 12 months, NPA has been classified under sub-standard assets because such advances possess more than normal risk, and the borrower’s creditworthinessCreditworthinessCreditworthiness is a measure of judging the loan repayment history of borrowers to ascertain their worth as a debtor who should be extended a future credit or not. For instance, a defaulter’s creditworthiness is not very promising, so the lenders may avoid such a debtor out of the fear of losing their money. Creditworthiness applies to people, sovereign states, securities, and other entities whereby the creditors will analyze your creditworthiness before getting a new loan.read more is weak. Such advances possess more than normal risk, and the borrower’s creditworthiness is quite weak. As a result, banks are generally ready to take some haircuts on the loan amounts categorized under this. For more than 12 months, NPA has been classified under sub-standard assets. Banks are generally ready to take some haircut on the loan amounts, which are categorized under this asset classAsset ClassAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples.read more.

#3 – Doubtful Debts

For a period exceeding 18 months, non-performing assets come under doubtful debts. Doubtful debts themselves mean that the bank is highly doubtful of the recovery of its advances. The collection of these advances is highly uncertain, and there is the slightest probability of recovering the loan amount from the party. Such advances can put the bank’s liquidityLiquidityLiquidation is the process of winding up a business or a segment of the business by selling off its assets. The amount realized by this is used to pay off the creditors and all other liabilities of the business in a specific order.read more and reputation in jeopardy.

#4 – Loss Assets

The final classification of non-performing assets is loss assets. This loan is identified either by the bank itself or an external auditorExternal AuditorExternal Audit is defined as the audit of the financial records of the company in which independent auditors perform the task of examining validity of financial records of the company carefully in order to find out if there is any misstatement in the records due to fraud, error or embezzlement and then reporting the same to the stakeholders of the company.read more or internal auditor as that loan where amount collection is impossible, and the bank has to dent its balance sheet. The bank, in this case, has to write offWrite OffWrite off is the reduction in the value of the assets that were present in the books of accounts of the company on a particular period of time and are recorded as the accounting expense against the payment not received or the losses on the assets.read more the entire loan amount outstanding or need to make a provision for the total amount which needs to be written off in the future.

Things Banks need to Bear in Mind Before Making Loan Advances

Following are the things banks need to bear in mind before making loan advances: –

#1 – Character

The borrower’s character needs to be judged, and the willingness of the company to repay debt needs to be evaluated at that time. In addition, they should also consider the management, history, revenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions.read more pipelines, stock performance, and media coverage of the company.

#2 – Collateral

The value of the collateralCollateralCollateralization is derived from the term “collateral,” which refers to a security deposit made by a borrower against a loan as a guarantee to recover the loan amount if s/he fails to pay.read more pledged needs to be assessed, and proper valuation of the property/asset should be done, keeping the loan to value ratioLoan To Value RatioThe loan to value ratio is the value of loan to the total value of a particular asset. Banks or lenders commonly use it to determine the amount of loan already given on a specific asset or the maintained margin before issuing money to safeguard from flexibility in value.read more in mind.

#3 – Capacity

The capacity of the banker to analyze the company’s financials and the future revenue projections. Also, existing lenders on the company’s balance sheet need to be adequately studied to get the right collateral before providing advances.

#4 – Condition

Lastly, the overall environment and the market and industryIndustryIndustrialization refers to the transformation of a manual labor-based economy to a machine labor-driven industrial society.read more conditions should be considered. In addition, a bank should consider external and internal factors that can affect the business in the future.

Big Credit analysisCredit AnalysisCredit analysis is the process of drawing conclusions about an entity’s creditworthiness based on available data (both quantitative and qualitative) and making recommendations about perceived needs and risks. Credit analysis also involves identifying, assessing, and mitigating risks associated with an entity’s failure to meet financial commitments.read more firms judge any company in the 4C parameter.

The banks are the backbone of an economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more that needs to strive in a dynamic and challenging environment. Hence, choosing the right clients and business partners will make the economy sustainable and save the world from another 2008 global financial crisisFinancial CrisisThe term “financial crisis” refers to a situation in which the market’s key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more. Furthermore, a proper strategy and restrictions should be implemented for banks to limit credit to only deserving corporations in non-performing assets.

Non-Performing Assets (NPA) Video

This article has been a guide to Non-Performing Assets (NPA). Here we discuss the top types of NPA and classifications of non-performing assets for banks. You may also take a look at the below useful articles:-

In banking terms, the various causes for the non-performing of assets are –Inappropriate credit appraisalReceivables poor recoveryLow-grade loan management policyNon-success of businessInactive judicial systemIndustrial downturnUnfavorable exchange rates

Overdraft, cash credit facilities, and agricultural loans are non-performing assets.

The company’s non-performing assets are cash and cash equivalents, accounts receivable, marketable securities, and trademarks.

Performing assets refer to the assets that maintain the cash flow to the lender/investor. In contrast, non-performing assets are those that are unable to make the payment within 90 days.

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