Page 208 - DCOM208_BANKING_THEORY_AND_PRACTICE

Unit 13: Non Performing Assets

NPAs, thus, make a two-pronged attack on the bottom-lines of commercial banks; one, interest Notes
applied on such assets is not taken into account because such interest is to be taken into account
only on its realization unlike interest on performing assets, which is taken into account on
accrual basis; two, banks have to make provisions on NPAs from out of the income earned by
them on performing assets.
Persistently, high level of NPAs in loan portfolio of banks make them fragile leading ultimately
to their failure. This will shake the confidence both of domestic and global investors in the
banking system which will have a multiplier effect bringing disaster in the economy.
Thus, managing bad loans and keeping them at the lowest possible level has become a keyword
for the banking industry in recent years.

Notes At this juncture those world-class banks do not have NPAs of over 2 percent of the
total portfolio.

An NPA level of over 5 percent is an indicator of poor quality of loan portfolio.

!
Caution With growing competition and shrinking spreads, banks should strive to keep
NPAs much below the level of 10 percent to make net earnings necessary for their survival
and growth.
Thus, the most critical condition for bringing about an improvement in the profitability of
banks is reduction in the level of NPAs. In fact, it is a precondition for the stability of the
financial system.

Self Assessment

Fill in the blanks:

1. Non-performing Assets concept was introduced by reserve bank of India on ......................
2. Non-performing assets are also known as ......................
3. An NPA level of ...................... is an indicator of poor quality of loan portfolio.

13.2 Conceptual Exposition of Non-performing Assets (Advances)

The RBI introduced in 1985-86 the Health Code System for commercial banks advising them to
recognize income only on realization basis, initially in respect of accounts under Health Code
No.6 and above, subsequently for those under Health Code No.5 too. While the Health Code
classification was serving as a useful Monitoring and Management Information Mechanism,
absence of a transparent, objective and uniform yardstick for measurement of problem (sticky)
advances was the major drawback of this system.

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