Managing Non-performing Assets (NPA) in Banking

Every loan a bank gives out is, technically, an asset. It’s supposed to bring in interest income month after month. But when a borrower stops paying, that asset stops earning – and eventually becomes a burden instead. This is the essence of a Non-Performing Asset, or NPA, one of the most closely watched numbers in Indian banking. Understanding how NPAs form, how they’re classified, and how banks fight to recover them tells you a lot about the health of the entire financial system.

What exactly makes a loan an NPA? 🔗

According to the Reserve Bank of India, a loan or advance turns into an NPA when the interest or principal payment remains overdue for more than 90 days. This 90-day rule has been in effect since the financial year ending March 31, 2004, when the RBI aligned Indian banking norms with international best practices. Before that, banks used a longer window, which allowed stress to hide in the books for longer.

The rule isn’t limited to term loans. Cash credit and overdraft accounts are treated as NPAs if the account stays “out of order” – meaning the outstanding balance continuously exceeds the sanctioned limit, or there’s no fresh credit for 90 days to cover the interest charged. Bills purchased or discounted by a bank are also flagged as NPAs if they remain unpaid past the same 90-day mark.

The early warning system: SMA accounts 🔗

Before an account technically becomes an NPA, banks track it as a Special Mention Account (SMA). This classification exists purely as an early-warning tool. Depending on how many days a payment is overdue, an account moves through SMA-0, SMA-1, and SMA-2 categories, giving banks a chance to engage the borrower before the account crosses the 90-day threshold and turns bad. This system, laid out in RBI’s income recognition and asset classification norms, helps banks act early rather than react after the damage is done.

How NPAs are classified 🔗

Not all NPAs are equally risky. Once an account crosses 90 days overdue, RBI norms require banks to classify it further based on how long it has remained non-performing. This matters because it directly decides how much money the bank must set aside as a provision – essentially, a cushion against potential loss.

This tiered system pushes banks to provision more aggressively the longer an account stays bad, which is a strong incentive to resolve stress quickly rather than let it linger.

Gross NPA vs net NPA: what’s the difference? 🔗

Gross NPA (GNPA) is the total value of all bad loans on a bank’s books, before any provisions are deducted. Net NPA (NNPA) is what remains after subtracting the provisions the bank has already set aside for those bad loans. A bank can have a high gross NPA but a low net NPA if it has provisioned heavily – this is often seen as a sign of prudence, even if the headline number looks worrying. Analysts usually watch both figures together, since gross NPA shows the scale of the problem while net NPA shows how much of it is genuinely unprotected.

Why do loans turn into NPAs? 🔗

NPAs rarely happen because of one single reason. A mix of internal and external factors usually plays out over time.

• Economic slowdowns: When demand falls or a sector faces disruption, businesses struggle to generate the cash flow needed to service debt.
• Poor credit appraisal: Loans sanctioned without adequately assessing a borrower’s repayment capacity are more likely to turn bad.
• Sectoral concentration: A large chunk of India’s NPA crisis in the mid-2010s came from heavy lending to power, steel, and infrastructure projects that didn’t perform as expected.
• Wilful default: Some borrowers have the capacity to repay but deliberately avoid doing so, often diverting funds elsewhere.
• External shocks: Events like droughts affecting farm income, or disruptions like the pandemic, can push otherwise healthy borrowers into default.

The real cost of rising NPAs 🔗

When NPAs pile up, the effects ripple through the entire banking system. Provisioning requirements eat directly into a bank’s profits, since money that could have been lent out or distributed as returns instead sits aside as a buffer. Persistent losses erode a bank’s capital base, which in turn limits its ability to extend fresh credit – a slowdown that can spill over into the broader economy. High NPA levels also dent public and investor confidence in a bank, sometimes triggering deposit withdrawals or a fall in share price for listed lenders. This is exactly what played out around 2018, when the gross NPA ratio of public sector banks touched a peak of roughly 14.58%, largely due to stressed exposures in power, steel, and infrastructure lending that had built up over the preceding boom-and-bust cycle.

How banks and regulators manage NPAs 🔗

Since the mid-2010s, India has built a fairly robust toolkit to recognise and resolve bad loans faster than before.

SARFAESI Act, 2002 🔗

The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act lets banks recover dues without going to court first. Once a loan is classified as NPA, the bank issues a notice under Section 13(2), giving the borrower 60 days to clear dues. If the borrower fails to respond, the bank can take possession of the secured asset under Section 13(4) and sell it to recover the outstanding amount. This route works only for secured loans and applies above a minimum outstanding threshold.

Debt Recovery Tribunals 🔗

Set up under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, these tribunals handle recovery suits filed by banks specifically against loan defaulters, offering a faster alternative to regular civil courts.

Insolvency and Bankruptcy Code, 2016 🔗

The IBC took a fundamentally different approach. Instead of just seizing assets, it created a time-bound process where a defaulting company’s control shifts away from its existing promoters while a resolution plan is worked out – either reviving the business under new ownership or liquidating it if revival isn’t viable. Cases are filed before the National Company Law Tribunal, and the entire framework is overseen by the Insolvency and Bankruptcy Board of India. The Code has meaningfully changed lender-borrower dynamics, since promoters now risk losing control of their company entirely if dues aren’t cleared.

Asset Reconstruction Companies 🔗

ARCs specialise in buying bad loans off a bank’s books, usually at a discount, and then work to recover value from them over time – through restructuring, litigation, or asset sale. This lets banks clean up their balance sheets quickly instead of chasing recovery themselves for years.

The 4R strategy 🔗

Since 2015, when the RBI conducted a system-wide Asset Quality Review to force banks to recognise hidden stress, the government’s approach has rested on four pillars: recognising NPAs transparently, resolving them through IBC and SARFAESI, recapitalising public sector banks with fresh capital, and pushing broader reforms in governance and underwriting standards. This strategy is widely credited for the sustained improvement in India’s banking sector that followed.

Where India’s NPA numbers stand today 🔗

The turnaround has been striking. India’s gross NPA ratio for scheduled commercial banks fell to 2.15% by September 2025, its lowest level since 2010-11, down from a peak above 11% in 2018. Net NPAs have fallen even further, reflecting stronger provisioning across the system. The recovery rate on bad loans resolved through the IBC has also nearly doubled, rising from about 13.2% in FY18 to 26.2% in FY25, showing that resolution mechanisms are working faster and more efficiently than before. Public sector banks, once the biggest source of stress, have seen some of the sharpest improvements, supported by recapitalisation and tighter underwriting discipline.

That said, the absolute value of NPAs in rupee terms remains meaningful even as ratios shrink, since total lending in the economy keeps growing. Analysts also flag that segments like unsecured retail loans and MSME credit need continued monitoring, since these can build stress quietly even while headline numbers look healthy.

What do you think? 🔗

What do you think? If gross NPA ratios keep falling as they have over the past decade, do you think Indian banks will eventually shift their focus from recovery to purely preventive credit appraisal? And between SARFAESI’s speed and IBC’s structured resolution process, which approach do you think serves the Indian economy better in the long run?

References

1. https://vivs.in/non-performing-assets-in-india-legal-recovery-guide/
2. https://bankofindia.bank.in/documents/20121/380921/Consumer_Education.pdf
3. https://www.business-standard.com/finance/news/banks-gross-npa-ratio-falls-below-3-a-first-since-2012-rbi-report-124062700950_1.html
4. https://www.drishtiias.com/daily-updates/daily-news-analysis/insolvency-and-bankruptcy-code-ibc-process
5. https://www.pib.gov.in/PressReleasePage.aspx?PRID=2225442&reg=3&lang=1
6. https://www.pib.gov.in/PressReleasePage.aspx?PRID=2220002&reg=1&lang=1