NPAs and provisioning

Chapter 3 said capital absorbs losses. This chapter is about when a loss has to be admitted, which is a different and more contested question.

The ninety-day line

The RBI's definition: an asset becomes non-performing where, for a term loan, interest and/or instalment of principal remains overdue for a period of more than 90 days.

The number is a convention. Its importance is that it is a bright line set by someone other than the bank. Without it, a bank deciding when a loan has gone bad would face every incentive to decide "not yet" — deferring the admission defers the provision, which defers the hit to profit and capital.

Note what the rule counts: days the oldest amount has been overdue, not the number of payments missed.

Working the problem: at 85 days the account is not yet an NPA. A payment clearing the oldest instalment resets the clock, and the account stays standard. The bank has avoided classification by six days.

That is why "evergreening" — lending a borrower just enough to keep an account current — is a supervisory concern rather than a clever technique. The rule can be satisfied without the underlying problem changing at all, which is precisely why supervisors look past the classification to the behaviour.

The four categories

Category	Definition
Standard	Performing; not an NPA
Substandard	"Has remained NPA for a period less than or equal to 12 months"
Doubtful	"Has remained in the substandard category for a period of 12 months"
Loss	Loss identified by the bank, its auditors or RBI inspection, but not yet written off wholly

The ladder is mechanical and time-based, which is the point. An account does not stay substandard because management believes recovery is coming; it moves because time passed.

A loss asset, in the circular's words, is one considered "uncollectible and of such little value that its continuance as a bankable asset is not warranted" — even if it carries some salvage value.

Provisioning

A provision is an expense recognised against an expected loss, which reduces profit and therefore capital. Chapter 9 of the Accounting subject is the general treatment; here the amounts are set by regulation rather than judgement, and they rise as an asset moves down the ladder.

This is deliberate. Leaving the amount to the bank would reintroduce the discretion the ninety-day rule removed.

Provision coverage ratio — provisions held against gross NPAs — is the figure to watch. Two banks with identical gross NPAs and different coverage have made different admissions about the same book.

Income recognition, and why it is the subtle one

The rule that catches people out: income from an NPA is not recognised on an accrual basis. It is booked only when actually received.

This is a deliberate departure from accrual accounting (chapter 5 of the Accounting subject), and the reason is sharp. Accruing interest on a loan that is not being paid would let a bank book revenue it will never collect, and grow the loan balance it is accruing on — manufacturing profit out of a deteriorating asset.

When an account becomes an NPA, previously accrued but uncollected interest must be reversed. So a classification does not merely stop future income; it reverses past income. That is why a wave of NPA recognition hits a bank's profit harder than the provisions alone suggest.

Gross and net

Gross NPA — the full value of non-performing loans. Net NPA — gross less provisions held.

A low net NPA with a high gross NPA means the bank has provided heavily: it has recognised the problem. A gross and net that are close means it has not.

Watch the movement, not the level. Fresh slippages — standard accounts becoming NPA in the period — say more about the current book than the stock does, because the stock reflects years of accumulated decisions and whatever has been written off.

Why this sector rewards scepticism

Loans go bad slowly. A bank that lends badly today reports excellent numbers for two or three years, because nothing is overdue yet and the interest is accruing.

The reported quality of a loan book lags the decisions that made it by longer than almost any other business. Rapid loan growth, especially in a segment the bank has not lent in before, is the leading indicator; the NPA ratio is the lagging one.

The point

An asset is non-performing when interest or principal has been overdue more than 90 days, and it moves mechanically through substandard, doubtful and loss as time passes — a bright line set by the regulator precisely because a bank left to judge it would always defer. Provisions are prescribed rather than chosen, and income on an NPA is recognised only when received, so a classification reverses past interest as well as stopping future interest.