Background:
By 70s, India nationalized most of its banks, and it was the period when India was suffering from such severe balance of payment crisis that India had to airlift Gold to IMF to loan money to meet its financial obligations. This crisis forced Government to take several steps to strengthen Indian financial system. The nationalized banks which were hitherto working on a very hypothetical profit making institutions were relooked and a committee was formed in the year 1990 popularly known as “Narsimhan committee”.
In the year 1991 this committee placed its recommendations for banking sector reforms, out of which one of its important recommendations was “Income recognition and asset classification of prudential norms” thereby defining Non-Performing assets (NPA). There were 2 Narsimhan committee recommendations placed in the year 1991 and 1998, popularly known as Narsimhan committee recommendation-I & Narsimhan committee recommendation-II.
What is NPA in Banking:
Instead of going detail into the recommendations of Narsimhan committee-I and Narsimhan committee-II, we will understand what is NPA (duly modified in Narsimhan committee-II)
Definition: An asset, including a leased asset, becomes non performing when it ceases to generate income for the bank.
A non performing asset (NPA) is a loan or an advance where-
– interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan,
– the account remains ‘out of order’ in respect of an Overdraft/Cash Credit (An account should be treated as ‘out of order’ if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for 90 days as on the date of Balance Sheet or credits are not enough to cover the interest debited during the same period, these accounts should be treated as ‘out of order’.
– the bill remains overdue (Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid on the due date fixed by the bank.) for a period of more than 90 days in the case of bills purchased and discounted,
– the installment of principal or interest thereon remains overdue for two crop seasons for short duration crops,
– the installment of principal or interest thereon remains overdue for one crop season for long duration crops,
– the amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken.
– in respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment.
Categories of NPAs:
Banks are required to classify non performing assets further into the following three categories based on the period for which the asset has remained non performing and the realisability of the dues:
Sub Standard Assets: With effect from March 31, 2005, a sub standard asset would be one, which has remained NPA for a period less than or equal to 12 months.
Doubtful Assets: With effect from March 31, 2005, an asset would be classified as doubtful if it has remained in the sub standard category for a period of 12 months.
Loss Assets: A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.
(checkout our post on How to Reduce Credit Risk in Banks)
Consequences of Accounts becoming NPA:
Banks incur two pronged losses in case of any account becoming NPA.
- As per the Narsimhan committee recommendations, the income from non -performing assets (NPA) is not recognised on accrual basis but is booked as income only when it is actually received. Therefore, the banks should not charge and take to income account interest on any NPA. If any advance, including bills ;purchased and discounted, becomes NPA, the entire interest accrued and credited to income account in the past periods, should be reversed if the same is not realised.
- A provision from P&L to be made against all NPA accounts, which is as under:
– Substandard Assets (15% of total outstanding)
– Doubtful Assets (25% to 100% of outstanding depending upon secured and unsecured portion)
– Loss Assets (100% of total outstanding)
In my next write-up I will discuss about NPA management and its recovery procedures.