Non-performing asset (NPA) is a classification used by financial institutions to describe loans and advances that is past due and without any form of interest payments paid.
In other words, it is a debt instrument where the borrower has not made any previously agreed-upon interest and principal repayments to the designated lender for the agreed or extended period. These loans and advances are either in default or in arrears.
A loan in arrears refers to a case when principal or interest payments are paid late or missed totally, while a loan is in default when the lender considers the loan agreement to be broken and the debtor is unable to meet his obligations.
Loans and advances become a Non-performing asset when they are outstanding for 90 days or more, even though some lenders use a shorter window in considering a loan or advance past due.
This is so because it is no longer yielding any income to the lender in the form of interest payments.
When a loan or an advance because a nonperforming asset, it is recorded on the balance sheet of a bank or other financial institution.
Moreover, after a certain period, the lender comes up with various strategies to force the borrower to liquidate any assets pledged as part of the debt agreement. In a case there are no assets, the lender might write off the asset as a bad debt and then sells it at a discount to a collection agency.
Sub-Classifications for Non-Performing Assets (NPAs
These refer to loans and advances that have been past due for anywhere from 90 days to 12 months, with a normal risk level.
This means the borrower(s) have exceeded the stipulated period for repayment.
These are higher NPAs that have been past due for more than 12 months. Due to the amount of time delayed without payment, they have a significantly higher risk level, combined with a borrower that has less than ideal credit.
This category involves debts that have been past due for at least 18 months. In this case, the lender or the financial institution is in serious doubt if the borrower will ever repay the full loan.
Here, lenders and financial institutions are past the doubting stage and have come to accept that the loan will never be repaid, and must record a loss on their balance sheet. The entire amount of the loan is written off completely as a loss.
Other categories of non-performing assets:
Although the most common nonperforming assets are term loans(as listed above), there are also other forms of nonperforming assets as well.
Overdraft and cash credit (OD/CC): This involves accounts left out of order for more than 90 days.
Agricultural advances: Cash paid for agricultural use but its interest or principal installment payments remain overdue for two crop/harvest seasons for short duration crops or overdue one crop season for long duration crops
Expected payment on any other type of account is overdue for more than 90 days.
Generally, both the borrower and the lender need to be aware of performing assets and non-performing assets.
This is because, if the asset is non-performing and interest payments are not made, it can negatively affect their credit and growth possibilities. This can hamper their ability to obtain loans and advances shortly.
In conclusion, non-performing assets can be manageable, depending on the amount and how far they are past due.
In the short term, most NPAs can be managed by financial institutions; however, if the volume or amount of NPAs continues to build over a while, it threatens the financial health and future success of the lender and might not be managed.Featured Image Source: Newsd
Got a suggestion? Contact us: firstname.lastname@example.org
You might also like:
- How To Raise Seed Funding For Your FinTech Startup
- 5 Ways To Effectively Cut Cost In The Face Of A Recession
- How Businesses Can Stay Financially Afloat In Downtimes
- 6 Financial Books To Read Before The End Of 2022