Non-performing assets (NPAs): A comprehensive guide by Bajaj Finserv AMC

Non-performing assets (NPAs) are more than a banking data point. When loan repayments weaken, banks may adopt a more cautious lending stance, and debt market pricing may adjust based on perceived credit risk. For mutual fund investors, this can be relevant, particularly for debt schemes that hold corporate bonds or bank-issued instruments, depending on portfolio exposure.

This article explains what non-performing assets mean, how the Reserve Bank of India classifies them, and how investors may track potential NPA-linked signals while assessing credit risk.

Table of contents

• What are non-performing assets (NPAs)?
• Understanding the causes of NPAs
• Classification of non-performing assets (NPAs)
• Impact of high NPAs on the economy and investments
• Measures to control NPAs: Government and RBI initiatives

What are non-performing assets (NPAs)?

A bank loan is treated as a performing asset as long as the borrower services the interest and principal within the agreed timeline. When repayments remain overdue beyond a specified period, the asset may stop generating income for the lender and is classified as non-performing. In India, bank loans are generally classified as NPAs when interest or instalments remain overdue for more than 90 days.

Official definition of NPA

According to the Reserve Bank of India (RBI), a non-performing asset (NPA) is a loan or advance that has stopped generating income for the bank because interest and/or principal have remained overdue for a period exceeding 90 days.

However, the RBI framework also provides for certain distinctions and exceptions based on the nature of the credit facility. For example, the criteria for classifying cash credit and overdraft accounts, agricultural advances, and some project loans differ from standard term loans. In such cases, asset classification may depend on factors such as whether the account is considered “out of order,” crop seasons, or project-specific timelines.

Understanding the causes of NPAs

Non-performing assets may rise due to a combination of macroeconomic conditions, sector-specific challenges, and lending practices. When credit expansion outpaces borrowers’ ability to generate sustainable cash flows, repayment pressure may build up over time. Weak credit appraisal standards or insufficient post-disbursement monitoring may allow such stress to intensify, particularly during economic slowdowns when corporate revenues face pressure.

Different sectors may carry different forms of credit risk. Agricultural lending may be influenced by weather patterns and seasonal income cycles, while unsecured segments such as personal loans or microfinance may experience higher delinquencies if household leverage increases beyond manageable levels. Policy changes and broader economic conditions may also influence the overall quality of bank assets.

Classification of non-performing assets (NPAs)

Once a loan is classified as an NPA, banks in India categorise it as substandard, doubtful, or loss assets based on the duration of default and expected recoverability. These classifications influence minimum provisioning requirements against potential losses.

Substandard assets

Substandard assets are NPAs that have remained in default for up to 12 months. Although repayments are overdue, the lender may still assess a possible recovery path, resulting in lower provisioning compared with later stages.

Doubtful assets

Doubtful assets are loans that have continued as substandard assets for more than 12 months. As uncertainty regarding recovery increases over time, provisioning requirements typically rise.

Loss assets

Loss assets are exposures identified as uncollectible by the bank, internal auditors, or supervisory authorities, even if a limited recovery value may exist. Such assets generally attract very high provisioning.

Impact of high NPAs on the economy and investments

Elevated levels of non-performing assets may affect bank profitability by reducing interest income and increasing provisioning costs, which may exert pressure on earnings and capital buffers over time. This may lead to more conservative lending practices, potentially slowing credit availability for businesses and consumers.

Higher NPAs may also influence investor perception of banking and credit markets, which could contribute to wider risk premiums. For fixed income investors, credit events or defaults may affect security valuations and, in turn, the net asset value of debt mutual fund schemes with credit exposure, depending on portfolio composition.

Measures to control NPAs: Government and RBI initiatives

India has introduced several frameworks to recognise and resolve stressed assets, including the Insolvency and Bankruptcy Code, 2016, which provides a creditor-led insolvency resolution process. Other mechanisms include Asset Reconstruction Companies, supervisory oversight by the RBI, and prudential norms related to recognition and provisioning.

For mutual fund investors, regulatory measures introduced by the Securities and Exchange Board of India, such as the Risk-o-meter, the portfolio risk classification matrix for debt schemes, valuation norms, and segregated portfolio provisions may enhance transparency around credit risk and the impact of credit events.

FAQs

How do high NPAs impact the net asset value (NAV) of a debt mutual fund?

If an issuer whose security is held by a debt scheme delays payments or experiences a credit event, the affected instrument may be marked down based on applicable valuation norms. Since a scheme’s NAV reflects the fair value of its holdings, this may result in a lower NAV. The extent of the impact depends on factors such as the size of the exposure, the credit profile of the issuer, and the overall portfolio composition of the scheme.

Are all types of loans equally likely to turn into NPAs?

No. Different types of loans carry different levels of NPA risk, depending on the borrower profile, loan structure, and economic conditions. For example, secured loans backed by collateral may have lower loss severity, though they can still become NPAs if repayments are delayed. Unsecured loans, such as personal loans or credit card debt, typically carry higher credit risk because they lack collateral support.

Similarly, retail loans (like home loans) often show different default patterns compared to corporate or project loans, which may be more sensitive to business cycles, regulatory changes, or execution delays. Agricultural loans also follow distinct NPA classification norms linked to crop cycles.

Overall, while any loan can turn into an NPA if repayment obligations are not met, the likelihood and impact vary across loan types, and are influenced by underwriting standards, economic conditions, and borrower behaviour.

What is the role of rating agencies in assessing NPA vulnerability?

Publicly available sources such as the Financial Stability Report, bank disclosures, and provisioning data may offer insights into system-level asset quality. Investors may also rely on credible financial reporting that references official data.

What is the role of rating agencies in assessing a company's debt and NPA vulnerability?

Credit rating agencies assess a borrower’s financial strength, business model, governance standards, and repayment history based on available information. Lower ratings generally indicate a higher probability of default and, therefore, higher potential NPA risk.

How has the Insolvency and Bankruptcy Code helped in reducing NPA in India?

The Insolvency and Bankruptcy Code introduced a time-bound, creditor-driven insolvency framework. In several large stressed asset cases, it has been associated with relatively higher recovery outcomes compared with earlier mechanisms, although results may vary across cases.