NPA

1. Meaning and recognition of NPAs

A bank's loans are assets because borrowers are expected to repay principal and interest. An asset becomes non-performing when repayment or servicing breaches the applicable regulatory threshold. RBI's Income Recognition, Asset Classification and Provisioning norms, commonly called IRACP norms, prevent banks from indefinitely treating unpaid interest as income and concealing deterioration in loan quality.

An amount is overdue if it is not paid on the due date fixed by the bank. For term loans, interest or an instalment of principal remaining overdue for more than 90 days generally triggers NPA classification. Bills purchased or discounted also generally become NPAs when overdue for more than 90 days. A temporary delay is therefore not necessarily an NPA, although it is an early warning of stress.

Cash credit and overdraft accounts use the 'out of order' test. This includes an outstanding balance continuously exceeding the sanctioned limit or drawing power for 90 days. An account may also be out of order when there are no credits continuously for 90 days, or credits are insufficient to cover interest debited during the preceding 90 days, even if the outstanding balance remains within the limit.

For specified agricultural advances, the threshold is overdue principal or interest for two crop seasons for short-duration crops and one crop season for long-duration crops. A long-duration crop has a crop season longer than one year. State Level Bankers' Committees determine crop seasons for individual crops. These exceptions should not be assumed to cover every rural or agricultural-related loan.

• Security does not prevent NPA classification: even a fully collateralised loan can become an NPA.
• Within a bank, classification is generally borrower-wise across credit facilities, subject to prescribed exceptions.
• An NPA is not automatically evidence of fraud or wilful default; genuine business failure can also cause non-payment.

2. Classification, provisioning and key ratios

A substandard asset has remained an NPA for a period of up to 12 months. A doubtful asset has remained in the substandard category for 12 months. A loss asset is one whose loss has been identified by the bank, auditors or RBI inspection but which has not been wholly written off. Such an asset is considered uncollectible and of little value as a bankable asset, although some recovery may remain possible.

Provisioning means recognising an expense and setting aside an accounting allowance against possible loan losses. Requirements generally increase with deterioration in asset quality, time spent in the doubtful category and the unsecured portion of exposure. Standard assets also attract provisions, so provisioning does not itself mean that a loan is an NPA. Loss assets should be written off or fully provided for if retained in the books.

Gross NPAs represent the total stock of loans classified as non-performing before the relevant deductions. The gross NPA ratio is gross NPAs divided by gross advances, multiplied by 100. Net NPAs deduct provisions and specified adjustments; the net NPA ratio uses net advances as its denominator. Thus, a low net NPA ratio may reflect substantial provisioning rather than an absence of underlying defaults.

Interest on NPAs is generally recognised when actually received, rather than merely accrued. A provision coverage ratio indicates the extent of provisioning against NPAs, though the precise reporting definition matters. A falling gross NPA ratio can result from recoveries, upgrades, write-offs or growth in advances; it does not by itself establish that borrowers have repaid all bad loans.

3. Causes, economic effects and early warning signals

NPAs arise from interactions between borrower weaknesses, lending practices and macroeconomic shocks. Common causes include poor project appraisal, excessive leverage, diversion of funds, weak monitoring, demand slowdowns, commodity-price changes and delayed statutory clearances. Infrastructure projects are especially exposed to construction delays and mismatches between long project gestation periods and financing arrangements.

India's stressed-loan cycle after the investment boom of the 2000s illustrated the twin balance sheet problem: heavily indebted firms were unable to invest, while stressed banks were reluctant or unable to extend fresh credit. RBI's Asset Quality Review initiated in 2015 helped expose previously under-recognised stress. A rise in reported NPAs following tighter scrutiny can therefore reflect better recognition rather than only fresh economic deterioration.

NPAs reduce interest income and require provisions that depress profits. Losses can erode capital, restricting lending capacity and weakening monetary transmission. Recapitalisation of public sector banks can impose a fiscal burden, while indiscriminate credit tightening may hurt viable enterprises. Resolution must balance recovery, productive credit supply and protection against moral hazard.

• For ordinary overdue loans, Special Mention Accounts identify early stress: SMA-0 covers amounts overdue up to 30 days, SMA-1 more than 30 and up to 60 days, and SMA-2 more than 60 and up to 90 days.
• Evergreening means extending or arranging fresh funds to conceal repayment stress without genuinely restoring borrower viability.
• Restructuring changes repayment terms or other contractual conditions; it does not automatically restore an NPA to standard status.

4. Recovery and resolution mechanisms

Debt Recovery Tribunals were established under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, now called the Recovery of Debts and Bankruptcy Act, 1993. They provide a specialised adjudicatory route for recovery. Lok Adalats and negotiated settlements can also help resolve suitable cases, especially smaller disputes.

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, known as SARFAESI, enables eligible secured creditors to enforce security interests without first obtaining a civil court decree, subject to statutory safeguards. Its recovery process ordinarily involves NPA classification and a 60-day demand notice. It is not a universal recovery power: statutory exclusions include security interests in agricultural land.

The Insolvency and Bankruptcy Code, 2016 provides a collective insolvency-resolution framework. Corporate insolvency cases are adjudicated by the National Company Law Tribunal. A committee of creditors evaluates resolution plans; approval requires at least 66% of its voting share. The objective is resolution and value maximisation, not simply debt collection. Failure to resolve may lead to liquidation.

Asset Reconstruction Companies acquire stressed financial assets and undertake reconstruction or recovery under the SARFAESI framework and RBI regulation. The National Asset Reconstruction Company Limited was incorporated in 2021. The government approved guarantees up to ₹30,600 crore for security receipts issued by NARCL. Such transfers can support specialised resolution, but shifting an asset off a bank's books does not itself revive the underlying business.

5. Write-offs, waivers and examination distinctions

A write-off removes a loan, wholly or partly, from the bank's balance sheet through an accounting process. In a technical write-off, the account may be written off at head-office level while remaining outstanding in branch records for recovery. The borrower's liability generally continues, and recoveries can occur subsequently. A waiver, by contrast, relinquishes the repayment claim to the extent specified.

A haircut is the reduction in the creditor's claim or economic recovery accepted during settlement or resolution. It is not identical to a provision, which recognises expected loss in the accounts. Similarly, bank recapitalisation strengthens the capital base but does not automatically resolve stressed borrowers. Sustainable improvement requires sound underwriting, timely recognition, adequate provisioning, effective resolution and better governance.

• NPA classification concerns repayment performance; capital adequacy concerns the bank's loss-absorbing capacity.
• An NPA can be upgraded only after satisfying applicable RBI conditions, not merely because a token payment is made.
• Assess asset quality using slippages, recoveries, upgrades, write-offs and provision coverage alongside headline NPA ratios.

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