In Banking field a term appeared is “NPA” which is Non-Performing Asset it describes the classification of loans and scheduled payments. Bank’s assets are the loans and advances given to customers. it is an important parameter to judge the performance and financial health of banks. It creates a bad effect on the goodwill and equity value of the bank. In this article, we will explain the effects of NPAs in banking.
The Effects of NPAs in Banking
The efficiency of a bank is not reflected only by the size of its balance sheet but also the level of return on its assets. The NPAs do not generate interest income for banks but at the same time, banks are required to provide provisions for NPAs from their current profits. The NPAs have a deleterious impact on the return on assets in the following ways.
- Lenders suffer a lowering of profit margins.
- Stress in banking sector causes less money available to fund other projects, therefore, negative impact on the larger national economy.
- Higher interest rates by the banks to maintain the profit margin.
- Redirecting funds from the good projects to the bad ones.
- As investments got stuck, it may result in it may result in unemployment.
- In the case of public sector banks, the bad health of banks means a bad return for a shareholder which means that the government of India gets less money as a dividend. Therefore it may impact easy deployment of money for social and infrastructure development and results in social and political cost.
- Investors do not get rightful returns.
- Balance sheet syndrome of Indian characteristics that is both the banks and the corporate sector have stressed balance sheet and causes halting of the investment-led development process.
- NPAs related cases add more pressure to already pending cases with the judiciary.
- The interest income of banks will fall and it is to be accounted only on receipt basis.
- Banks profitability is affected adversely because of the
- providing of doubtful debts and consequent to writing it off as
- Return on investments (ROI) is reduced.
- The capital adequacy ratio is disturbed as NPAs are entering into its calculation.
- The cost of capital will go up.
- The assets and liability mismatch will widen.
- The economic value addition (EVA) by banks gets upset because EVA is equal to the net operating profit minus cost of capital and it limits recycling of the funds.