Understanding NPAs: Classification and Provisioning
Detailed study of what constitutes a Non-Performing Asset in the Indian banking system, the Special Mention Accounts (SMA) classification, and the categories of NPAs based on the duration of default.
Expert Answer & Key Takeaways
Detailed study of what constitutes a Non-Performing Asset in the Indian banking system, the Special Mention Accounts (SMA) classification, and the categories of NPAs based on the duration of default.
1. What is a Non-Performing Asset (NPA)?
An asset becomes non-performing when it ceases to generate income for the bank.
Definition:
According to the Reserve Bank of India, an NPA is a loan or an advance where:
- Interest and/or installment of principal remain overdue for a period of more than 90 days in respect of a term loan.
- The account remains 'out of order' in respect of an Overdraft/Cash Credit (OD/CC).
- The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted.
Agriculture Exception:
For agricultural loans, a loan is an NPA if the installment of principal or interest remains overdue for two crop seasons (for short duration crops, e.g., paddy) or one crop season (for long duration crops, e.g., sugarcane).
2. Special Mention Accounts (SMA)
To capture early warning signals of distress and prevent loans from slipping into NPAs, RBI introduced the SMA classification before the 90-day mark.
- SMA-0: Principal or interest payment not overdue for more than 30 days but account showing signs of incipient stress.
- SMA-1: Principal or interest payment overdue between 31 to 60 days.
- SMA-2: Principal or interest payment overdue between 61 to 90 days.
Note: If the payment remains overdue beyond 90 days, it is officially classified as an NPA.
3. Categories of NPAs
Once an asset becomes an NPA (post 90 days), banks are required to classify it into three categories based on the period for which the asset has remained non-performing and the realizability of dues.
- Sub-standard Assets: An asset that has remained NPA for a period less than or equal to 12 months.
- Doubtful Assets: An asset that has remained in the sub-standard category for a period of more than 12 months (i.e., it has been an NPA for more than 24 months total).
- Loss Assets: An asset where loss has been identified by the bank or internal/external auditors or the RBI inspection, but the amount has not been written off wholly. Such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted.
4. Provisioning Norms
Provisioning means setting aside a portion of profits by banks to cover expected losses from bad loans. High NPAs require higher provisioning, which directly erodes the bank's profitability.
General Provisioning Guidelines (Subject to RBI updates):
- Standard Assets: Usually requires a general provision of 0.40% (except highly volatile sectors like commercial real estate which require more).
- Sub-standard Assets: 15% provision is required for secured exposures; 25% for unsecured.
- Doubtful Assets: Under 1 year (25%), 1 to 3 years (40%), More than 3 years (100% allowed on secured portion).
- Loss Assets: 100% provisioning is required.
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