THE CRUCIAL factor that decides the performance of banks nowadays is the spotting of non-

performing assets (NPA). NPAs are those loans given by a bank or financial institution where the
borrower defaults or delays interest or principal payments.

Banks are now required to recognize such loans faster and then classify them as problem assets.
Close to 16 per cent of loans made by Indian banks are NPAs - very high compared to say 5 per
cent in banking systems in advanced countries.

Banks are not allowed to book any income from NPAs. Also, they have to provision for the NPA,
or keep money aside in case they can't collect from the borrower, which impacts profitability
adversely.

How are NPAs classified?

In line with RBI guidelines from time to time, the loans given by banks are classified as
performing and non-performing for the purpose of income recognition and provisioning. The
criteria for classification are :

Performing / Standard Assets: Loan assets in respect of which interest and principal are
received regularly are called standard or performing assets. Standard assets also include loans
where arrears of interest and /or of principal do not exceed 180 days as at the end of a financial
year. No provisioning is required for such loans.

Non-Performing Assets: According to RBI rules, any loan repayments which is delayed beyond
180 days has to be identified as an NPA. NPAs are further sub-classified into sub-standard,
doubtful and loss assets:

Sub-standard Assets: Sub-standard assets are those which are non-performing for a period not
exceeding two years. Also, in cases where the loan repayment is rescheduled, RBI has asked
banks to recognize the loans as sub-standard at least for one year.

Doubtful Assets: Loans which have remained non-performing for a period exceeding two years
and which are not considered as loss assets. A major portion of assets under this category relate
to `sick' companies referred to the Board for Industrial and Financial Reconstruction (BIFR) and
awaiting finalization of rehabilitation packages.

Loss Assets: A loss asset is one where loss has been identified but the amount has not been
written off wholly or partly. In other words, such an asset is considered uncollectible. There may
be some salvage value.

How do banks provide for NPAs?

The RBI has also laid down provisioning rules for the non-performing assets. This means that
banks have to set aside a portion of their funds to safeguard against any losses incurred on
impaired loans. Banks have to set aside 10 per cent of sub-standard assets as provisions. The
provisioning for doubtful assets is 20 per cent and for loss assets it is 100 per cent.

What is the magnitude of the problem?

According to the latest RBI figures, gross NPAs in the banking sector stands at Rs 45,563 crore
which is about 16 per cent of the total loan assets of the banks. The net NPAs (gross NPAs
minus provisioning) stands at Rs 21,232 crore which is about 7 per cent of loans advanced by the
banking sector.
Though in percentage terms, the NPAs have come down over the last 5-6 years, in absolute
terms they have grown, signifying that while new NPAs are being added to banks' operations
every year, recovery of older dues is also taking too long.

Eventually, increasing NPAs means that the funds locked are not being used properly or are not
producing adequate returns. If a bank has high NPAs, then it may not be able to earn enough to
pay depositors interest or repay their principal.

What is ever-greening or rescheduling of loans?

Sometimes, to avoid classifying problem assets as NPAs, banks give another loan to the
company with the help of which it can pay the due interest on the original loan. While this allows
the bank to project a healthy image, it actually makes the problems worse, and creates more
NPAs in the long run. RBI discourages such practices.

How to solve the NPA problem? What steps have been taken so far?

Banks need to have better credit appraisal systems so as to prevent NPAs from occurring.
However, once NPAs do come into existence, the problem can be solved only if there is enabling
legal structure, since recovery of NPAs often requires litigation and court orders to recover stuck
loans. With long-winded litigation in India, debt recovery takes a very long time.

Banks are now working on developing debt recovery tribunals to solve this problem. The
government has also mooted the suggestion of an asset reconstruction company, which will be a
specialized agency set up for rehabilitating revivable NPAs (say, salvaging projects which are
inherently sound) and recovering funds out of un-revivable NPAs (gone cases).

Experts have also suggested the concept of narrow banking, where only strong and efficient
banks will be allowed to give commercial loans, while the weak banks will take positions in less
risky assets such as government securities and inter-bank lending.