Effect of NPAs
Carrying nonperforming assets, also referred to as nonperforming loans, on the balance sheet places three distinct burdens on lenders. The nonpayment of interest or principal reduces cash flow for the lender, which can disrupt budgets and decrease earnings.
Loan loss provisions, set aside to cover potential losses, reduce the capital available to provide subsequent loans. Once the actual losses from defaulted loans are determined, they are written off against earnings.
Recovery of loses
Lenders generally have four options to recoup some or all of the losses resulting from nonperforming assets. When companies struggle to service debt, lenders can take proactive steps to restructure loans to maintain cash flow and avoid classifying loans as nonperforming. When borrowers’ assets collateralize defaulted loans, lenders can take possession of the collateral and sell it to cover losses to its market value.
Lenders can also convert bad loans into equity, which may appreciate the point of full recovery of principal lost in the defaulted loan. When bonds are converted to new equity shares, the value of the original shares is usually wiped out. As a last resort, banks can sell bad debts at steep discounts to companies specializing in loan collections. Lenders typically sell defaulted loans that are not secured with collateral or when the other means of recovering losses are not cost-effective.
Loss assets
As per RBI, “Loss 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.”
Doubtful assets
An asset will be classified as doubtful if it has remained in the substandard category for 12 months.
Substandard assets
That particular NPA remains overdue for less than or equal to 12 months.
Norms of provisioning
The norms of provisioning are being set by the Reserve Bank of India and are the same for all the banks concerning NPA. They may vary to an extent as per the NPA category. Ten percent of the allowances are applicable for the total amount unpaid without making any budget for the securities or any other coverage of government guarantee. The NPA that falls in the substandard category would add another 10 percent coverage making this a total of 20 percent of the total outstanding amount. The provisional requirement for a doubtful or unsecured NPA is declared to be 100 percent.
Nonperforming assets and their effects
