When an asset generates some income or revenue, it is considered a Performing Asset (PA). When that asset stops generating income, it is considered a Non- Performing Assets (NPA).
A Non-Performing Asset is a loan asset that stops generating any income, either in fee commission, interest, or other costs. There is always a debate amongst economists that an ideally working financial process allows smooth regulation of investments and savings, leading to economic growth.
What is a balanced financial system?
A well-maintained financial system helps to accomplish a well-organized distribution of resources over time by eliminating the inadequacies taking place due to other market resistances and socio-economic factors. In a well-operating financial system, managing Non-Performing Assets is a crucial part. Non-Performing Assets, after a certain point, are a cause of concern for every firm, as they affect the smooth flow of credit. Credit is the most important aspect for any business as it helps in the growth of the company.
In the highly competitive banking world, daily customer service progress is the most helpful instrument for better growth.
Categories of Non-Performing Assets
On knowing which assets are Non-Performing Assets, the banks should divide them into three categories depending on the period they stayed non-performing:
- Substandard Asset
- Doubtful Asset
- Loss Assets
Substandard Assets
A substandard asset is the one that has stayed Non-Performing Asset from less than or equal to 12 months. In this case, the security charge’s present value is not enough to guarantee full due recovery to the bank. In simple words, this type of asset will include the asset’s highly defined weaknesses, which threatens the debt’s liquidity. Furthermore, such assets are ranked according to the loss they will incur to the bank if the insufficiencies aren’t corrected.
Doubtful asset
Doubtful assets are the ones that have been in the substandard category for full 12 months. A loan becomes doubtful when it inherits all the qualities defined in substandard assets along with traits of lacking liquidity. Based on present known conditions, facts, and values, such assets get highly questionable.
Loss asset
Loss assets are the ones where internal or external auditors or banks notice a loss, but that amount is not stated completely. In simple words, an asset is thought unredeemable and of such little importance that it is not included as a bank’s asset. In such assets, the guarantee of getting back the value is so little that even with having a bit of hope of recovery, the banks don’t consider paying attention to them.
Why do Non-Performing Assets occur?
The reason behind the occurrence of Non-Performing Assets is bad loans. Generally, it is the failure to complete the financial commitments, state it as a non-ability to pay the loan. Such loans can come due to the given reasons:
- General banking procedures, including bad lending systems
- Overhang components usually occur due to natural disasters, environmental issues, diseases, business cycles, etc.
- A banking crisis that recently occurred in Japan, South Asia, and the USA
- Incremental components caused due to internal bank management, including terms of credit, credit policy, etc.
Non-Performing Assets are not restricted to bad impressions on account books only, but they have a massive effect on the national economy. Here are some of the impacts of Non-Performing Assets:
- For the compensation of the Non-Performing Assets losses, banks increase interest rates on some of their products and services
- Loss of uninsured deposits happen, thus the depositors don’t enjoy the complete returns
- Bank shareholders get affected badly
- Funds are redirected from good to bad projects that result in bad investments, which adversely impact the economy
- No or low repayment of loan and interest lead to liquidity problems
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