CAMELS-Asset Quality

Loan classification refers to the process

banks use to:
review their loan portfolios and
assign loans to categories or grades based on:
the perceived risk and
other relevant characteristics of the loans.
 The process of continual review and
classification of loans enables banks to:
monitor the quality of their loan portfolios and,
when necessary to take remedial action:
to counter deterioration in the credit quality of their
portfolios.
 CAMELS-Asset Quality

From an accounting perspective, loans should be

recognized as being impaired, and necessary
provisions should be made, if it is likely that the
bank will notCAMELS-Asset Quality
be able to collect all the amounts due
principal and interest according to the contractual
terms of the loan agreements .
Loan loss provisioning is thus a method that banks
use to recognize a reduction in the realizable value
of their loans.
 CAMELS-Asset Quality

Non recovery of installments as also interest

on the loan portfolio negates the
effectiveness of this process of the credit
cycle.
Avoidance of loan losses is one of the pre-
occupations of management of banks.
 CAMELS-Asset Quality

While complete elimination of such losses is

not possible, bank managements aim to keep
the losses at a low level.
In fact, it is the level of non-performing
advances which, to a great extent,
differentiates between a good and bad bank.
 Assets.
The solvency of financial institutions
typically is at risk when their assets become
impaired, so it is important:
to monitor indicators of the quality of their assets
in terms of overexposure to specific risks,
trends in nonperforming loans, and
the health and profitability of bank borrowers
especially the corporate sector.
 CAMELS-Asset Quality

What is NPA
To begin with, it seems appropriate to define Non
Performing Assets popularly called NPA.
Non Performing Assets is defined as an advance
where payment of interest or repayment of
installment of principal or both remains unpaid for
a period of two quarters or more.
An amount under any of the credit facilities is to be
treated as 'past due' when it remains unpaid for
specified days beyond due date.
 CAMELS-Asset Quality

NPAs have a DELETERIOUS effect on the return

on assets in several ways
They erode current profits through provisioning
requirements
They result in reduced interest income
increased pressure on net interest margin (NIM) thereby
reducing competitiveness,
steady erosion of capital resources
increased difficulty in augmenting capital resources.
reputational risks arising out of greater disclosures on
quantum and movement of NPAs, provisions
 CAMELS-Asset Quality

Factors For Accumulating NPA

Internal factors
Diversion of funds for
expansion / diversification / modernization
taking up new projects
helping/promoting associate concerns
Time/cost overrun during the project implementation stage
Business (product, marketing, etc.) failure,
Inefficient management,
Strained Labour relations,
Inappropriate technology/technical problems,
Product obsolescence, etc.
 CAMELS-Asset Quality

External factors
Recession,
Non-payment in other countries
Inputs/power shortage,
Price escalation,
Accidents, and natural calamities, etc.
Changes in government policies in excise/import
duties, pollution control orders, etc.,
 CAMELS-Asset Quality

Risks to the solvency of financial institutions

most often derive from impairment of assets.
The quality of financial institutions loan
portfolios is also directly dependent upon the
financial health and profitability of the
institutions, borrowers, especially the
nonfinancial enterprise sector.
 CAMELS-Asset Quality

The ratios of nonperforming loans (NPLs) to total

loans is often used as a proxy for asset quality of a
particular bank or financial system.
Some countries use forward-looking classification
criteria, which focus on repayment capacity and
cash flow of the borrower, and mirror more
accurately the current economic value of a loan,
therefore providing better quality indicators.
 CAMELS-Asset Quality

For countries that are using the usual

classification system, which includes four
categories:
standard,
substandard,
doubtful and
loss,
NPLs are often defined as loans in the three
lowest categories.
 CAMELS-Asset Quality

A summary of CAMELS indicators

Asset Quality
NPLs to total gross loans
Provisions in percent of NPLs
Provisions to total gross loans
Dilution in profit due to provision