On the basis of performance of assets, banks classify their assets into two broad categories, namely performing and non-performing.
Normally every asset of the bank falls under Performing (Standard) assets as soon as it becomes the right of the bank. Performing assets are those which do not carry more than normal risk of recovery and do not disclose any problems. Assets on which interests, instalments and payments are received regularly at due dates are classified as performing assets or standard assets.
Identification of Non-Performing Assets
There are detailed guidelines issued to banks by the Reserve Bank of India regarding identification of advances between performing and non-performing assets. The following are the criteria laid down in order to identify NPAs-
1. Term Loans
Term loans become NPA if their amount(interest or principal) remains overdue wholly or partly for a period exceeding 90 days. For example, if the interest due by a customer on 1 March 2021 hasn't been paid till 31 May 2021, then the loan will be classified as a non-performing asset for the bank.
2. Bills Purchased and Discounted
Bills become NPA if interest or instalment of principal remains overdue for a period exceeding 90 days, the same case as of term loans.
3. Cash Credit or Overdraft
They are treated as NPA if they become out of order.
Out of Order simply means-
A. If the outstanding balance of account remains continuously in excess of the sanctioned borrowing power of the person,
B. If there have been no credits in the account for a continuous period of more than 90 days.
C. The interest of outstanding balance in account is not covered by the credits of the account.
D. If the amount due to the bank is not paid on the due date fixed.
4. Government guaranteed advances
Credit facilities backed by guarantee of the Central Government shall be treated as NPA only when the government takes back or repudiates its guarantee. Thus, mere being overdue of these advances shall not lead to classification as NPA. However, if the advances are backed by the State Government, then they shall be treated as NPA if they are overdue for more than 90 days.
Classification of Non-Performing Assets
According to RBI norms, banks must categorize their NPAs in different segments, according to the period of their non-performance. The following are the segments under non-performing assets-
1. Sub-Standard Assets
A sub-standard asset is one which has been classified as an NPA for a period not exceeding 12 months. This indicates that the repayment of debt is not certain and there's a possibility that the bank would sustain some loss , if deficiencies are not corrected.
Example - A loan on which instalment hasn't been paid for 6 months, is a sub-standard asset for the bank.
2. Doubtful Assets
An asset would be classified as doubtful, if it has been in the sub-standard category for a period of at least 12 months. In clear terms, if an asset has been an NPA for more than 12 months, it becomes doubtful. A doubtful asset makes the collection of the asset highly questionable and improbable.
Example - Interest on term loan hasn't been paid for a period of 15 months, then it is a doubtful asset.
3. Loss Assets
An asset which has been considered irrecoverable by the bank or auditors or the RBI inspectors, but the amount has not been written off yet, is referred to as loss assets.
Example - Due to regular faults in repayment, the auditor of bank has classified a loan to be uncollectible. Thus the loan becomes a loss asset.
The arising question in your minds would be why do banks classify their assets in these categories. The answer for the question is lies in the fact that banks are required create provisions on their assets, based on the risk involved in the assets. The assets which are less risky have less provisioning requirement, whereas assets involving huge risk of collection require greater provision, following the principle of prudence.
The following table states the percentage of provisions prescribed for each category of bank assets.