In the account books of banks, the deposits made by public are categorised as liabilities while the loans and advances made by the banks to its customers are categorised as assets.
According to RBI those assets on which the instalments of interest or principle or both remain overdue for a period of 90 days of more are classified as Non-Performing Assets (NPAs). In other words, those assets of banks which have stopped performing are NPAs.
Amount of NPAs with Banks
Today, the Indian banking industry is dealing with the mammoth amount of NPAs which is fifth largest in the world. As on June 30, 2018, the gross NPAs of the banking sector were 11.52% of the total assets while the net NPAs were 5.92%. As on March 31, 2018, the gross NPAs were at 11.68% and net NPAs were 6.21%. Thus there is slight improvement in NPAs this year.
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Factors behind High NPA Growth
- From 2006-2011, Indian economy was going through high growth phase and consequently there was a rapid credit growth.
During the period from 2006-2011, when GDP growth rate was an all-time high, the growth of industrial credit was much higher. Even when the overall credit growth declined, the industrial credit increased. When after 2011, the GDP growth mellowed down, the profit margin of industrial sector declined and corporates started defaulting their loan payments and NPAs started increasing.
- In 2015, RBI revised its guidelines for NPAs after which, banks had to recognise some assets as NPAs which were earlier accounted as standard assets. This lead to the sharp increase in NPAs after 2015 merely due to accounting changes. In other words, some NPAs were not recognised as NPAs by the banks.
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Impact on NPAs on Banks
The increasing NPAs not only reduce the profitability of banks but also affect its credibility. In fact the massive amount of NPAs with commercial banks is threatening to erode half of the capital base of public sector banks.
Once a bank started incurring losses and if the fundamentals are not corrected, the problem may become chronic and destabilize the confidence of the depositors. Once the depositors start withdrawing their money from the banks, the banking system will collapse. It is because of this reason that NPAs must always remain within the sustainable limit and the current level of NPAs is threatening the stability.
Higher amount of NPAs also pressurise banks to decrease the interest rate on saving deposits to increase the margin. Already there is a gap between interest rate on bank savings vis-a-vis savings in other non-banking accounts like PPF, post office saving schemes etc. Further, several mutual funds are providing returns of more than 10%. Further diversion in interest rates will divert the funds from banking sector to non-banking sector further eroding the capital with banks.
Thus, the increasing NPAs pose long-term threats to the stability of banking sector.
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Impact of NPAs on Industry
As stated earlier the credit growth to the industrial sector was higher as compared to the GDP growth and over credit growth during the period 2006-11. As a result, the proportion of NPAs in industrial sector was much higher vis-à-vis other sectors. Consequently, in the later phase, banks were reluctant to fund the needs of industrial sector hampering its growth. In fact, in some cases like that of the Micro, Small and Medium Enterprises (MSME) industry, credit actually shrank.
The slowdown in growth in post-demonetization period also resulted in reduced profitability of the manufacturing sector which further prompted the banks to stall the credit growth to the industrial sector. In the long term, the shortage of funds to the industrial sector will affect the growth of the industrial sector.
After 2014-15, the credit growth to the industrial sector is least as compared to the credit growth to the agriculture and service sector. The continuous shrinking of credit to industrial sector is detrimental to not only industries but overall economy as well.
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Impact on Indian Economy
Strong banking sector is one of the most significant prerequisite of strong economy because it channels the savings into the investment. A fragile banking sector will ultimately give way to the fragile economy.
The major sectors of the Indian economy contributing to the NPAs are as under –
It is clear that infrastructure accounted for biggest chunk of NPAs. Because of massive amount of NPA in infrastructure, the banks are now reluctant to fund this sector. As the infrastructure is one of the most important sectors in economy which fuels the growth of other sectors, draining of resources to infrastructure may hamper the growth of Indian economy.
Among the other sectors, food processing also accounted for 5.3% of total NPAs. Food processing is one of the most employment intensive industries and its growth also pushes the growth of agriculture. Any loss to the food processing industry will ultimately percolate to the employment as well as agriculture sector.
Other sectors will also directly or indirectly affect the overall economic scenario due to the exposure to the bad loans. Hence, the issue of NPA must be resolved on urgent basis.
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