Definition
Non-Performing Assets (NPA) are loans or advances that banks or financial institutions have made that are in jeopardy due to defaults or late payments. Essentially, they are assets that are not producing income. This typically occurs when a debtor has not made the required payments for 90 days or more.
Key Takeaways
- Non-Performing Assets (NPA) are loans or advances that are in jeopardy of default, meaning the borrower has stopped making interest or principal repayments for at least 90 days.
- High levels of NPA indicate poor credit decisions by the bank, reducing the profitability and leading to erosion of the value of the asset.
- The identification, measurement, monitoring and control of NPAs are important for the banks and financial institutions because they have a direct impact on their profitability and capital adequacy.
Importance
The term Non-Performing Assets (NPA) is paramount in finance because it provides an indication of the credit risk that a bank or financial institution is facing.
NPA refers to loans or advances that are in jeopardy due to defaults or prolonged non-payment by the borrower, making it difficult for the lender to recover the principal amount or interest.
A high level of NPAs suggests high probabilities of a large number of credit defaults that contribute to losses, ultimately deteriorating the financial health and profitability of the institution.
Therefore, regular monitoring of NPAs helps the institution minimize risks, manage its loan portfolio effectively, and improve its financial performance and stability, which is essential for the overall health of the economy.
Explanation
The purpose of the term Non-Performing Assets (NPA) in finance is to classify loans or advances that are in jeopardy of default. This classification plays a critical role within financial institutions, such as banks, because it helps to identify assets that are not generating revenue, thus posing a risk to the institution’s fiscal health.
By defining these risky assets as NPAs, the financial institutions can take proactive measures to manage these loans, such as enforcing loan recovery and improving their lending practices. Non-Performing Assets serve as an indicator of the financial health of banks and financial institutions.
High levels of NPAs suggest that there might be a lot of delinquencies or defaults in a bank’s existing loan portfolio, indicating poor credit decision-making, perhaps poor collection processes, or customer defaults. This information is useful for regulators, investors and management, who can then take corrective actions as necessary.
In essence, NPAs are used for managing credit risks, enhancing profitability, and ensuring the overall sustainability and reputation of the financial institution.
Examples of Non-Performing Assets (NPA)
Lehman Brothers: A prominent real world example of Non-Performing Assets (NPA) is the infamous case of Lehman Brothers, a global financial services firm that filed for bankruptcy in
The company held massive amounts of mortgage-backed securities and other loans that fell into the NPA category as borrowers defaulted on their payments, ultimately leading to the largest bankruptcy filing in the history of the United States.
Indian Banks NPA Crisis: In the period of 2014-2018, Indian banks faced a severe crisis due to mounting NPAs. A significant portion of these NPAs were large corporate loans. The heavily indebted infrastructure, steel, and telecommunications sectors contributed significantly to these NPAs. The cumulative NPAs of Indian banks reached an alarming USD 150 billion in 2018, leading to a banking crisis and economic slowdown.
Puerto Rico Debt Crisis: The island defaulted on a USD 422 million debt payment in May
It was a consequence of a decade-long economic recession and significant borrowing to balance the budget. The loans to Puerto Rico became Non-Performing Assets for entities that had lent the money, leading to a massive debt restructuring under U.S federal oversight.
Frequently Asked Questions about Non-Performing Assets (NPA)
What is a Non-Performing Asset (NPA)?
A Non-Performing Asset (NPA) is a loan or advance that is in jeopardy of default. Once the borrower has failed to make interest or principal payments for 90 days the loan is considered non-performing.
What are the types of NPA?
There are two types of NPA, Gross NPA and Net NPA. Gross NPA refers to the sum of all loans due to the bank (principal and interest). Net NPA is Gross NPA minus provisions held (such as interest in suspense and provisions for doubtful debts).
How does NPA affect the economy?
High levels of NPA in a bank negatively impacts the economy. It is a drain on the bank’s resources because not only do they stop earning interest on the loan, they also have to make provisions for potential losses in the future.
What is the cause of NPA?
The main causes of NPA are an economic slowdown, mismanagement of the loans by banks, willful default or fraudulent activity by the borrowers, and legal loopholes that allow defaulters to go unpunished.
How can NPA be reduced?
NPA can be reduced by improving the credit appraisal system, setting up separate stressed asset management branches, recovery of loans through the legal process, restructuring of accounts, and bringing about reforms in the Bankruptcy code.
Related Entrepreneurship Terms
- Loan Default
- Bad Debt
- Asset Quality
- Risk Management
- Debt Recovery
Sources for More Information
- Investopedia: This comprehensive finance education website contains a vast array of information about financial terms including Non-Performing Assets (NPA).
- The Balance: The Balance is a great resource for all sorts of financial information, including in-depth articles discussing Non-Performing Assets.
- Coursera: This online learning platform offers courses from universities and companies worldwide, including courses on finance where Non-Performing Assets (NPA) might be discussed.
- The Motley Fool: This financial service company provides a wide range of financial, investing, and credit advice including topics such as Non-Performing Assets (NPA).
