Banks play an important role in the development of a country because they provide loans to end customers(like home loans, car loans etc) and businesses(for expansion or launching new product etc). Bank loans are the growth engine of job creation and ultimately triggers consumer spending(employee receiving and spending the salary).
When a bank gives loan for an individual or a company – the agreement is that loan taker would pay the bank the principal amount along with pre-agreed interest component. If a customer continues to make the payment on time – the bank classifies the loan account as “Performing Asset”. However, at times, customers do not pay(or are unable to pay) interest or principal or both and in this case, the loan turns into a “Bad Loan. If a loan remains “Bad Loan” for a fixed period of time then it is classified as “NPA”.
As per RBI(Reserve Bank of India) guidelines, if a lender does not make principal or interest payment on a loan for over 90 days from end of a particular quarter – then the loan is classified as NPA(Non Performing Asset)
What is Provisioning Coverage Ratio?
Although banks do a thorough analysis before disbursing loans – still some loans become NPA because of uncontrollable factors. In order to keep banks in a good financial health, they are required to maintain a Provisioning Coverage Ratio as per RBI guidelines. The idea is that even if some of the loans disbursed become “bad loans” then the provisioning should help banks in maintaining their financial health.
To re-iterate – Provisioning is the funds which banks need to keep aside(from profit) for all loans disbursed.
The amount of provisioning depends upon two factors:
- Total Amount of loan disbursed by the bank.
- Performance of the loan which has been disbursed.
Picture below describes the provisioning ratio mandated by RBI as per their latest policy:
Provisioning is like an insurance policy which banks have to take for all disbursed loans – as per the RBI guidlines.
Some numbers on NPA in India
Although NPA was always a problem for Indian banking system, however, the banks tried to ignore the problem. Starting Dec-2015, Dr. Raghuram Rajan(then RBI governor)- started pushing banks to clean their balance sheets and give correct numbers of existing NPA’s. Although banks initially resisted with passing time – Indian banks have started taking the NPA issue head-on.
NPA is a huge problem for India, the combined total NPA reported by banks(both Public and Private) was 829338 crores (over 8 lakh crores) as of June-2017. With a GDP number of around 1138994 crores(over 113 Crores) – the GDP vs NPA ratio is around 7% which is HUGE.
The graph below outlines the declared NPA over last 6 quarters.
Non Performing assets is a huge problem for a developing nation like India. Lately, the government has been taking steps like NPA ordinance which empowers RBI to directly intervene in bad loans resolution to assist & aid banks. We are hopeful that with political will & support, RBI would be finally above to cure the cancer of NPA in our economy.