NPA: Causes and Effects


NPA (non-performing asset), I guess you’re already aware of the term, cause that’s the devil causing great harm to the Indian economy for a long time. So, we’ll be discussing NPAs in this article giving a great emphasis to their implications and ways to minimize them, including India’s recent conditions and how covid-19 has made it worse.

NPA meaning

Image by – The Economic Times

According to the definition, an NPA is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days. NPA is also called a ‘bad loan’.
Let’s simplify the term with an example – If a bank or a lending institution extends a loan to a company worth $5 million, with a $5000 interest payment. So, if the company consequently fails to pay the interest amount for a period of 3 months, then the loan would be considered as an NPA.

Well, the definition is not certain and is different for different types of lenders and borrowers.
For example – In India, for agriculture loans, the period is tied with the period of the concerned crops ranging from two crop seasons to one-year overdue norm.

NPA Classification –

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  • Substandard Assets – NPA for a period equal to or less than 12 months
  • Doubtful Assets – NPA that has remained in the substandard category for a period of 12 months
  • Loss Assets – NPA which is identified as lost but hasn’t been written off by the bank

The banks generally, for a considerable period of time, try their best to retrieve the bad loans with the available methods.
In India, a bank or a lending institution would try its best to retrieve the bad loan by methods such as IBC (Insolvency and Bankruptcy Code), etc.

IBC: What’s the insolvency and bankruptcy code?

The Law was implemented in India on 19th August 2016. The IBC law aimed at creating a framework that would consolidate and ultimately simplify and hasten the resolving of insolvencies in India, which was quite a long and unhurried process in India, causing great inefficiencies.

Image by – The Financial Express

The IBC law states – An act to consolidate and amend the laws relating to reorganization and insolvency resolution of corporate persons, partnership firms, and individuals in a time-bound manner for maximization of value of such persons, to promote entrepreneurship, availability of credit, and balance of interests of all the shareholders including alteration in the order of priority of payment of Government dues to establish an Insolvency and Bankruptcy Board of India, and for matters connected therewith or incidental thereto.

NPA in India. What’s causing these NPAs?

As I said earlier, the NPA problem is not a recent phenomenon in the Indian economy. But when does this problem actually originate?

  • The Indian economy was rising at a great pace in the 2000s with new enterprises coming into play and the existing ones experiencing newer highs. This led to increasing elasticity in the economy with the banks and other lending institutions lending extensively to these corporates. But however, this extensive elasticity ultimately turned out to be unsustainable, and it led to irrational exuberance to some extent. So, when India was hit by the global economic depression in 2008, the corporates were adversely affected. And with their earnings collapsed, so did their ability to repay the debts. This caused great losses to the banks as many of these loans extended became non-performing assets.
    (Irrational exuberance – Federal Reserve Chairman Alan Greenspan popularized the term which means irrational investor optimism which causes the asset prices to rise higher than their fundamentals justify.) 
Image by – The Balance
  • Another problem was, and continue to persist even after stringent guidelines by the RBI, in the Indian Banking System is the irrational lending practices by the banks. Banks tend to lend some corporates without proper scrutiny, without analyzing their financials and their repaying abilities. Hence, there is a much greater probability that they’ll default. For example – Kingfisher. This was also the reason why many economists in India opposed the formation of a bad bank in India because they believe that the setup would incentivize irrational lending practices by the banks.
  • Another major contributor to this problem isn’t quite irrational but rather meant for welfare. Priority Sector Lending (PSL) sector which includes agriculture, MSMEs, education, etc, is causing a large amount of NPAs in various banks, especially SBI.
  • And the recent conditions need no introduction, the pandemic has severely affected the economy, causing a large number of defaults, both in loans extended to businesses and individuals.

NPA: How do they affect the systems?


It would be quite evident for you after reading the blog that the sector most affected by the NPAs is banking. As banks pile up with non-performing assets, their profits substantially decrease and they sometimes end up in the negative zone. The high NPAs are also the biggest reason for their collapse.

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As banks pile up with bad loans, their balance sheets start looking more gruesome, adversely affecting their credibility. This altogether makes their depositors’ confidence tremble, which often leads to a reduction in their overall depositors ultimately affecting their capital base. Some banks even underreport their NPAs in order to escape from this, but however, end up in a bad position in the long run.

Industrial and Agriculture sector

As NPAs rise in banks, their lending capabilities get severely affected and loans extended to corporates get reduced. This reduction in NPAs limits the capital supply for the industries which eventually slows down their growth and even halts it. Even after the banks are liquidated by the government, they still are reluctant to lend, and sometimes the scrutiny adopted by the banks becomes excessive, halting the credit growth.

Image by – MBA Rendezvous

The case is somewhat similar for the agriculture sector as banks become reluctant to lend to the farmers, and others employed in the sector, especially the smaller ones. The PSL (Priority Sector Lending) operations might also become sluggish. As the farmers’ creditworthiness is already not in a good position and the formal source credit flow becomes inactive, due to increased scrutiny. So, farmers tend to move towards informal sources. Due to the high rate of interests charged by the informal sources, farmers’ profitability reduces and the whole sector gets severely affected.

NPA in India: How NPAs are affecting our economy?

Credit flow, which is the lifeline of any economy, is experiencing a massive downturn. And a good credit flow is the prerequisite for economic growth, hence, it also halts our economic growth.

It won’t be wrong to say that the banking system is the pillar of any economy and a stable and strong banking system would ultimately mean a stable economy. But that’s surely not the case of India, even after the conditions of banks today are much better than it was a few years ago thanks to the government and RBI, it’s still far from stable. With the Indian Banking System severely affected by the phenomenon, one cannot expect the Indian economy to grow at a regular rate. And this statement is very well justified by our Chief Economic Advisor, Mr. Krishnamurthy Subramanian.
He quoted, “India can’t become the third-largest economy with the health of the banking system that it has.”

What could be done to reduce the burden on banks?

Bad Bank
Image by -Yadnya Investment Academy – Invest Yadnya

The pandemic has again put the Indian banks in crisis, whose recovering phase was not complete yet. It has caused an extra burden on the banks as there’s a quantum jump in the number of loan defaults due to the financial crisis caused by Covid-19.

Undergoing structural reforms to reduce the NPA generation would require a considerable amount of time and the need of the hour is a measure that would reduce the burden on the banks, may it be temporary. So, the Indian Banking Association has drafted a proposal for setting up an asset reconstruction agency generally called a ‘bad bank’. The bad bank would be a specialized agency that would be set up to absorb bad loans from the banks and recover as much as possible. The agency would have one sole purpose, to recover the bad loans.
Read more about Bad Banks – Bad Bank : Solution to the banking crisis?

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