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How NPA Rots Banking System?

How NPA Rots Banking System?

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Post MBA entrance exams when you will face GD & PI and during this period, your information on current affairs will prove to be very handy, not only content wise but you will remain a confident personality.

Following article on “How NPA Rots Banking System?” should give insight  to you.

The Non-Performing Assets (NPA) is a term referred to those kinds of loans and advances in banking channels for which, the borrower fails to make any payment in interest or principle for 90 days and there is a high risk of default. However, in terms of Agriculture / Farm Loans; any advance is considered as NPA if the loan (instalment / interest) for short duration crop is not paid for 2 crop seasons. For Long Duration Crops, default for one Crop season from the due date is considered as NPA.

According to the Financial Stability Report 2017, released by the Reserve Bank of India (RBI), India’s gross NPA stands at 9.6% of the GDP which is second highest among the major economies after Italy (16.4%). However, India’s problem with NPAs is not comparable to the debt ridden countries like Greece and Ukraine which have NPA of 36.3 and 30.5%. 

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Reasons behind Rising NPAs

During initial years of 21st century till the global financial meltdown, Indian economy was going through booming phase and it witnessed the highest ever growth rates of GDP. During this phase, corporate sectors in India anticipating robust growth took massive loans from the banks and invested in projects with long gestation period such as power, ports, airports, housing, highway construction and iron and steel. 

In the year 2008, global economy faced a meltdown and it started impacting Indian economy after 2010 affecting the growth of Indian industries. Apart from this, policy paralysis also stuck the government of India due to the 2G and Coalgate scams and many such projects for which banks granted huge chunks of loans got stalled. Corporates involved in such projects were unable to pay instalments and the loans which looked lucrative prior to 2008 gradually turned unprofitable and became NPAs in the second decade of 21st century. On December 31, 2017, the cumulative effect of local and global events increased the total dues of industry to the public sector banks to INR 6,09,222 crore, accounting for 20.41% of the gross advances.

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Impact Of NPAs On banks

Banks in their account books enter loans and advances as assets which accrue interest income to the banks. Any reduction in these assets affects the income of banks and consequently the profitability. Due to inclusion of NPA's, the calculation of capital adequacy ratios also gets disturbed and cost of capital goes up. Thus the high level of NPAs also affect the stability of banks. 

Increase in NPAs not only affect the banking sector but other areas too. As the NPAs affect the lending capacity of banks, it affects the potential genuine borrowers. In order to compensate the cost of rising NPA, banks also redistribute the losses to other borrowers by charging higher interest rate thus escalating the cost of borrowing. 

Increase in borrowing cost for other borrowers effect their profitability and thus the capacity to invest is reduced which ultimately affects the growth.     

Banks also face liquidity crunch if NPAs rise above threshold and it may jam the payments of banking sector.      

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NPAs And Stressed Assets

Though NPAs are considered as a tool to assess the health of banking system, stressed assets provide a better picture of the overall situation in the system. The stressed assets in a bank refers to the NPAs plus restructures loans plus written off loans. The restructured loans are those loans which are rescheduled by the banks in order to give another chance to the borrower to repay his loans. Written off loans are those assets of the bank which are considered to be non-collectable such as a loan to a defunct business or a credit card due which is in default. 

Measures to Curb NPA Growth

Banks must make vigorous effort to strength their risk management system and internal control.  For that matter, banks are required to establish a credit monitoring system. The procedure of loan approval must include full information related to the client, management, company, industry etc. Banks should monitor whether the loan availed is used for the same purpose or is diverted for some other purpose as happened in Kingfisher case.

As we all know that investments is the basic requirement for growth, banks help in garnering the savings for investment. The rising amount on NPAs affect the conversion of savings into the investment and thus the overall investment scenario in the country. Therefore, it is of utmost importance for the government to undertake all the short term and long term measures to pull out the banks from the crisis and make permanent solution by not just dealing with the effects of NPAs but the causes behind rising NPAs. 

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