Why NPA Continues to be a Sore for Banking Industry?

Why NPA Continues to be a Sore for Banking Industry?

According to Reserve Bank of India “an asset including a leased asset becomes non-performing asset when it ceases to generate income for the bank.” The banks lend money to corporate and retail borrowers. Almost three-fourth of the corporate borrowers end up as defaulters contributing to NPAs. According to the latest CARE Ratings, India’s NPA is 9.85 percent which is higher than countries like China, Brazil, South Africa and Russia.

Banking sector plays crucial role in mobilizing the valuable resources of the country. NPAs are a significant parameter to judge the performance and financial health of banks. The level of NPAs is one of the drivers of financial stability and growth of the banking sector.

NPA: Reasons for High Number of NPA in Indian Banking Industry

The performance of public sector banks is worse than the private sector banks. This is mainly because the stressed assets are huge among PSU banks. The RBI’s Financial Stability Report (FSR) released in December 2019 warns that there will be an increase in the bad debts over the next few quarters. This is mainly due to weak macro situation, high slippages and low credit growth. The report mentioned, “Banks’ credit growth remained subdued at 8.7 per cent during the year ended Sept 2019, though the number of private banks was 16.5 percent.” It is estimated that the gross NPA ratio of the PSU banks will rise from 12.7 to 13.2 percent in September 2020.

Some of the reasons why there is an increase in NPAs (‘bad’ or ‘faulty’ loans) in the Indian Banking sector are:

  1. Inefficient Management & Tracking

The entire loan approval process is complex, lengthy and multi-layered. The monitoring of credit files is often avoided due to complexity. The lack of a system in place to keep track of the borrower’s performance is an add on. There is no proper follow-up of the money that is lend out as loans. Such warning signals are ignored which leads the standard assets to slip into the NPA category.

  1. Lack of Transparency

There is lack of transparency and accountability in the banking system. The auditing practices are poor and not up to the mark.

  1. Poor Coordination

It is often noted that the coordination between the banks and financial institutions is poor. There is funding mismatch where loans granted for short terms are used to fund long term transactions. This discrepancy increases NPAs.

  1. Political, Social and Fiscal Compulsions

PSU banks are often seen working under the aegis of Government and its related institutions. Sometimes the NPA borrowers are unable to compete with the lower prices and better choices available to consumers. The interest rates are often very high. All these contribute to higher NPAs.

  1. Mismatched Expectations

Overoptimistic promoters sometimes set up large projects with the expectations of high returns. However due to unfavorable and volatile market conditions the returns are not high or as expected and the lenders are left stranded due to unfinished projects.

  1. Willful Defaulters

Sometimes the borrowers do not wish to repay loans even if they have the means to pay.

NPA: Impact on Banks

The impact of high NPAs on the Indian banks are:

  1. Low profitability of banks.
  2. Affects the credibility of banks.
  3. Reduction of recycling of funds and inhibits the banks ability to lend funds.
  4. Shakes shareholders confidence.
  5. Adds on to risk-weighted assets.
  6. Hampers growth as banks lower interest rates on deposits and levy higher interest rates on advances to sustain net interest margin.

It is critical to adopt and implement corrective measures to reduce NPAs as it continues to sore the banking industry.

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