What is a Non-Performing Asset (NPA)? How assets are classified?

Assets for a bank are the loans it has given and investment made by the bank. Most important assets for banks are loans given by it. Similarly, banks make investment in government securities by purchasing them.

Usually, the health as well as the financial condition of a bank is measured through the proportion of bad assets or Non Performing Assets with it.

Simply, NPA indicates the amount of loan that was not returned by the customer. An asset becomes non-performing when it ceases to generate income for the bank.

As per the current norm, if a loan is overdue during the last 90 days, it will be categorized as a Non Performing Asset (NPA). A loan whose interest and / or installment of principal have remained 'overdue due' for a period of 90 days is thus considered as NPA. Overdue is a situation where the loan is not paid by the due date fixed by the bank.

From the banks’ health point of view, higher the NPA, lower will be its health. Attempt to strengthen a bank is mainly concentrated on NPA management.

Some of the assets of the banks may not have returned or were not repaid for a considerable point of time. Here, to measure the seriousness of repayment delay, assets are classified into different categories.

How assets are classified?

Assets of a bank are classified in terms of its repayment status. Standard assets, substandard assets, doubtful assets and loss assets are classifications of asset quality.

For a bank, classification of assets into different categories should be done taking into account credit weaknesses and the extent of dependence on collateral security for realization of dues.

What is a standard asset?

Standard Asset is one which does not disclose any problems and which does not carry more than normal risk attached to the business. Such an asset should not be an NPA.

What is a substandard asset?

A sub­standard asset would be one, which has remained NPA for a period less than or equal to 12 months.

What is a doubtful asset?

An asset would be classified as doubtful if it has remained in the sub­standard category for a period of more than 12 months.

What is a loss asset?

An asset that is an NPA for a period of more than 36 months is treated as a lost asset. Such asset has been identified by the bank or internal or external auditors or by the RBI inspection but the amount has not been written off wholly. In other words, such an asset is considered uncollectible.

Loss assets should be written off. If loss assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for. This means that full amount of the loss assets should be kept from some other sources like profit of the bank to meet the loss.

The mechanism of Provisioning is done to address the asset quality deterioration for a bank’s assets. The worse is the assets’ quality; higher will be the provisioning coverage ratio. Banks should make provision against sub­standard assets, doubtful assets and loss assets in a differential manner.