Impact of Non-Performing Assets on India’s GDP
Let us know what NPA is?
Non-performing assets (NPA) arise when the borrower fails to pay back the loan or interest to the
bank in a stipulated time period. Reserve Bank of India, being a monetary watchdog defines NPA as
“a loan or advance for which the principal or interest payment remained overdue for period of 90
days”. NPA’s are different from defaults because defaults are “delay in loan/interest repayment by a
single day”.
NPA is considered as the asset for the bank since they receive the loan back from the borrowers
along with the interest earned on it whereas NPA is a liability for the borrowers since they have to
pay back the loan amount with interest to the bank within a given time duration. The loans generate
income for the banks and if these assets stop generating income, it becomes a non-performing asset
for them.
Current level of NPA’s?
Till the year 2014, the banks were understating their non-performing assets since the banks realised
that writing-off NPA’s will add to their expenses that would further erode the profit margins. But the
understatement was not the correct thing to do! Therefore, the RBI along with the Government
introduced an Asset Quality Review in 2014 under which the banks were required to mandatorily
show their NPA’s. This step taken by the government led to a tremendous rise in the NPA levels that
were never seen before. NPA’s rose from 4% in 2014 to 11% in 2018. Banks had soon started to
write-off their NPA’s in their balance sheets and writing-off led to a slight fall in NPA levels to a new
low at 9.1% in 2019-20.
How do banks write off their loans and reduce the level of NPA?
A loan write-off is a tool used by banks to clean up their balance sheets. If a loan turns bad due to
repayment defaults for at least 3 consecutive quarters, the loan can be written-off. For Example, if a
bank disburses loan of Rs.1 Crore for a borrower and makes 20% provision for the same so the bank
sets aside another Rs.20 lakh (that goes to expense account of bank). If the borrower makes a
default of Rs. 60 lakh, the bank writes-off additional 40 lakh mentioning it as an expense in the
balance sheet. So as the loan is written-off, it also frees Rs. 20 lakh that was originally set aside for
provisions and unused. This money can then be available to bank for its business. This money going
forward can be used by the banks for lending to other borrowers and earn interest on it. This is how
the write-off helps a bank and hence their NPA’s can come down. The banks however, will recover
the default money through Insolvency and Bankruptcy Code (IBC), 2016 and any recovery made
against the borrowers becomes profit for the bank in that particular year of recovery.
Why NPA’s are important for determining economic growth?
When NPA ‘s increase in the bank, the bank profit margins erode and banks would increase their
credit costs to compensate their shrinking profits, the lending of banks decrease since they do not
have enough liquidity to lend to other borrowers, the provisioning coverage will have to be
increased and the loans are written-off. Therefore, with the rise in non-performing assets, the credit
cycle slows down, investments decrease, productivity in the country also decrease. This hits the
economic growth of the country in an adverse manner.
Last Words:
It is very important for the banks to identify the reasons behind the non-performing assets. NPA’s
could arise either due to wilful default where the business owners try to channelize their loans for
their personal/illegal use or NPA’s could also arise if the businesses have not made expected
earnings due to lack of demand for their products, lack of investment opportunities and
manufacturing facilities amidst the macroeconomic uncertainties that could not fetch them profits
to scale up their operations and hence due to insufficient liquidity could not repay the bank loans in
time. So when the banks do not get the money that is supposed to come back to them, it affects the
GDP growth of the country.
