The role of the banking system is crucial in the financial sector. For a healthy economy, it is important that the banks function well and maintain their profitability.
However, in the past few decades, there has been a major impact on the credibility of banks and financial institutions due to a phenomenon known as “Non-Performing Assets” or NPA.
In fact, some major financial frauds and scams have been possible because of the poor management of NPA in India.
What is NPA? NPA is nothing but loans sanctioned to the customers but not repaid in the sanctioned duration. When Non-Performing Assets keep on increasing, the financial situation of the bank deteriorates.
Impact of NPA on banks
There has been a big impact on the health of banks, that resulted in the process for NPA account settlement and NPA management in India. Some of the major impacts are:
Liquidity position
When the bank realizes that there is a liquidity crunch for a future business concern, it affects the position of the bank and creates a mismatch between its asset and liability. The bank is forced to raise resources at a higher rate.
Dent to the image
The big impact of NPA on a bank is a dent in its position and image in the market. When the profitability of a bank goes down, its image also shatters.
Impact on its funding
An increase in non-performing assets results in a scarcity of funding to other borrowers. The bank will not get money from its lenders. It will result in a liquidity crunch.
More cost of capital
It has been observed that NPA in India has resulted in an increased cost of capital. It is because banks are required to put aside more money for their smooth operations.
Higher risk
There is a high risk in business. The risk-bearing capacity of the bank is also gets affected.
Impact on profitability
When NPA goes beyond a limit, the bank is unable to create further assets because of a lower capital adequacy ratio and low capital ratio.
Such banks and financial institutions face difficulty with the growth and expansion plans. They face stagnation and negative growth. The net interest income goes down because they do not charge interests on the NPA accounts.
Servicing NPA will incur costs but there is no income generated. It means, the profitability further goes down.
So, there are severe impacts on the overall health and performance of banks due to NPA.