What are NPAs and why do you need to know this?

Nirav Modi, Mehul Choksi, Vijay Mallya have certainly fled away but have left behind the humungous sum of non-performing assets for the country’s banking system. Non-performing assets are a classification given for loans and advances that are in default of scheduled payment of principal or interest. A debt is classified as non-performing when it is overdue for a period of more than 90 days however this period can vary according to the terms of the contract.

Mehul Choksi (Credits: business today)

What causes NPTs? 

To understand NPAs, it is imperative to understand what causes it. The reserve bank of India prescribes a credit policy to which all commercial banks have to adhere under which the banks have to extend 40 percent of total loans to the priority sectors like agriculture, micro, and small industries etc. effect of which: if a bank is not satisfied with the financial position of an applicant from the priority sector, the bank still sanctions the loan in order to meet the criteria. The sectors like agriculture and allied activities are profit volatile thus there are high chances of default. Lenient lending terms of banks or favoritism by bank officials at the top management also end up in providing huge sums of loans to people who have less chance to repay. In public sector banks, the top management provides further funds to people in order to repay their earlier dues. This is done just to show good records during their term. However, in long-term, this creates bigger NPAs as the principal amount is never repaid and the interest liability keeps on increasing. The borrower may not utilize the funds in accordance with the terms of the contract and invest in a risky venture which may ultimately fail to generate enough cash flows, a situation regarded as moral hazard in macroeconomics, is also a big cause of rising NPAs in India.

(Credits: cfo-india.in)

And this may lead to…

The problem of NPAs leads to a problem of twin balance sheet. This is mounting up of nonperforming assets in the balance sheet of banks and at the same time increasing liabilities in the form of interest burden and principal repayment in the balance sheet of the borrower. When the amount of NPAs increase to a large extent and banks are not able to sustain these amount, the government has to come to their rescue to prevent the banks from failing and retain the faith of the public in the banking system. This poses a huge burden on the government treasury which may lead to inflationary situations in the economy.

Here are the loopholes

The banks and financial institutions have not been able to catch hold of the defaulters because they flay away to countries such as Antigua and St. Lucia and get their citizenship and either India does not have extradition treaty with such countries or the legal; process is too tedious to get hold of the person once he gets the citizenship.

What should be done? 

The banks may refrain from extending loans to subprime borrowers just to increase their market share in the credit market. Moreover, banks can also exercise strict monitoring of the activities of the borrowers which can be done by having nominee director on the board of borrower company which will help in preventing the problem of moral hazard as mentioned earlier.



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