NPA: Impact on Banking & Economy

Over the past decade, Indian banks have frequently been in the news due to the rising issue of NPAs (Non-Performing Assets) and the subsequent wave of mergers. But what exactly are NPAs? What factors contribute to their growth, and how do they impact banks? Do they also influence the stock prices of the banks concerned? Let’s explore each of these questions in detail.

What is NPA?

A Non-Performing Asset (NPA) refers to a loan or advance for which the principal or interest payment has remained overdue for more than the stipulated period generally 90 days. According to the RBI, an asset becomes “non-performing” when it stops generating income for the bank.

Banks further classify NPAs into three categories:

1. Substandard Assets – Loans that remain NPA for up to 12 months.
2. Doubtful Assets – Loans that continue to remain substandard for more than 12 months.
3. Loss Assets – Loans where repayment is considered impossible. In such cases, the bank must accept the loss and write off the entire amount.

How do NPAs affect banks?

Banks play a vital role in the economy by collecting deposits from the public and lending these funds at a higher interest rate. The difference, called Net Interest Income (NII), sustains their operations. When loans turn into NPAs, banks face significant challenges:

• Erosion of trust: Rising NPAs damage the bank’s reputation. Depositors may lose confidence and withdraw their money, creating liquidity problems.
• Reduced lending capacity: With lower liquidity, banks cannot fund new businesses or projects, slowing down economic activity. This can trigger a chain reaction leading to unemployment, inflation, and bearish market conditions.
• Higher interest rates: To maintain profitability, banks may hike interest rates, further discourage borrowing and hurt economic growth.

Causes of the NPA crisis in India

• Excessive lending during the 2000s boom: Businesses borrowed heavily for infrastructure and power projects. Many of these projects later turned unviable due to rising costs, delays, and the aftereffects of the 2008 global recession.
• Weak credit appraisal and corruption: Inadequate due diligence by banks, coupled with cases of willful default and mismanagement, worsened the crisis.
• Balance sheet stress: By 2013, NPAs had already weakened bank balance sheets, and by 2021, the problem had nearly doubled in scale.

Measures to tackle NPAs

To address the crisis, the Government of India and the RBI implemented several initiatives:

• Establishment of Debt Recovery Tribunals(DRTs).
• Promotion of Asset Reconstruction Companies (ARCs).
• Introduction of Corporate Debt Restructuring (CDR) and the Insolvency and Bankruptcy Code (IBC).
• Mission Indradhanush for public sector bank reforms, with ₹70,000 crore infused into PSBs.
• Asset Quality Review (AQR) to identify stressed assets.
• Use of Lok Adalats and the Credit Information Bureau to handle smaller cases.

One of the most significant steps was the merger of public sector banks (PSBs) reducing their number from 27 to 12. This move aimed to strengthen balance sheets, improve liquidity, diversify risk, and create stronger institutions capable of tackling NPAs effectively.

Conclusion

The problem of NPAs has posed one of the most significant hurdles for India’s banking sector in recent years. Non-performing loans not only erode bank profitability and strain liquidity but also reduce public trust, creating broader disruptions in economic growth. Nevertheless, measures such as regulatory reforms, the Insolvency and Bankruptcy Code, and the consolidation of public sector banks have strengthened the system’s ability to respond. Looking ahead, stronger credit assessment, sound risk management practices, and greater accountability will be crucial for ensuring a stable and growth-oriented banking sector.