We often hear the word NPA in news, but there is very little information available for the general public regarding what is NPA and why it is a big deal for the banks. We will try to understand the concept in very simple terms and with day-to-day life examples. Let’s cut out the jargon.
What is NPA?
NPA means a non-performing asset. Let us break the phrase into smaller terms. Firstly, NPA is an asset. An asset is anything that you may own; something that can bring you income, or something that earns or saves you money. You own a farmland, that’s an asset. You have gold, that’s an asset. A house, a tractor, a cow, a bicycle, a bullock cart, a car, anything that you own is an asset.
We know that NPA –i.e. a non-performing asset– is bad. The opposite should be good. An asset must perform. It is of no use if it doesn’t work for you. You have a car, but that doesn’t work and stay lying in the garage. Your asset stopped performing. You got a non-performing asset, an NPA.
We’ll take an example to understand how assets turn NPA. Let’s say, you own a car and you want to rent it out to generate some income for you. You rent your car to your neighbor and the rent is decided Rs. 10,000.00 per month. Each month, the neighbor gives you Rs. 10,000.00 and you put it in your profit. So, the car is earning you profit every month and you still own it. You can ask it back whenever you need it. The asset is earning profit for you. It is performing.
What happens if the neighbor refuses to pay you the decided rent? For the first month, you may say it is okay. There might be some financial problem at the neighbors’. If you trust your neighbor enough, you may wait for even more couple of months. But at some point, you must recognize that you are not going to get any rent and now you need to ask your car back.
But what if the neighbor denies even to return the car? In this case, your loss will be two-pronged. On one hand, you’ll stop getting your regular rent. On the other hand, you are at risk of losing your own asset. Your asset is an NPA.
What is provisioning?
Let’s say, your car was bought with borrowed money from one of your friends and you need to return her the money at some point. You are neither getting your rent nor getting the car back. But you must return the money you borrowed. What options do you have? You must keep aside some money from your income (generated from other assets) to repay your borrowed funds. This is provisioning. Eventually, the provisioning money is a part of your profit you keep aside for canceling the loss you suffered from the NPA.
What is write-off?
While you are keeping aside the money in provisioning, at some point, you’ll gather enough money to repay your friend the whole amount you had borrowed from her. At this point, on one hand, you will still have a car nominally (that is not helping you anything). On the other hand, you will have enough amounts to cancel out the car from your assets. After all, you cannot keep boasting having a car till eternity. You’ll cancel the car with the money you have in provisioning. The non-performing asset is cleared from your books. Your books are clean again.
Are there any options for you after the write-off?
Of course, you wrote off the car from your calculations, but your neighbor is not yet freed from the debt. He still owes you. You can go to court, or perhaps he has a change of heart and wants to repay or settle some amount with you. If this happens, and you get some recovery, the recovery gets straight to your profit as and when you actually receive the money. The recovery goes to profit because you had already paid for the asset from your profit.
What are a bank’s assets? How do banks decide an asset is performing or not?
The loans banks give to borrowers are the assets for the bank, because they earn interest on those loans. The rules for deciding if a loan is performing or not are decided by the Reserve Bank of India. Generally, a loan is considered NPA when the EMIs or interest is not paid for 90 days. After 90 days, the asset is considered sub-standard; after one year, doubtful; and when there is no hope left, it is considered as a loss asset. Sub-standard, doubtful, and loss are all different stages of NPA. In a loss account, banks need to do full provisioning and write it off from their books.
Why do some banks tend to hide NPA?
Banks generally work on the trust of their depositors. There are also shareholders who want to earn profit and dividends from their investment. If the amount of NPA is significantly high, the banks necessarily need to make provisioning. As provisioning is done straight out of profit, it brings the profit down significantly. Sometimes, even it may happen that the provisioning required is greater than the profit earned, and the banks need to declare a net loss for that period. Declaring a loss may shake trust of the depositors and they may withdraw their money in panic. It may happen that the bank is left with no funds to give loans. A loss also means falling share price in the market and hence loss to the shareholders.
Why the role of RBI is important?
NPA hidden under the carpet is not NPA non-existent. You cannot pretend to have a car when your neighbor neither returns your car nor pays the rent. RBI regulates the banks in India and it is in public interest that it needs to keep a check on how banks maintain their books. RBI sees that a loss is recognized as a loss and provisioning is made to counter that loss. RBI decides the rule-book for diagnosing non-performing assets. An early diagnosis and quick treatment is what keeps the banks in good health, and that’s the job of RBI.
