NPAs do not just reflect badly in a bank’s account books, they adversely impact the national economy. Following are some of the repercussions of NPAs:
Depositors do not get rightful returns and many times may loose uninsured deposits.
If there is a high number of non-performing assets in a bank’s portfolio, then in order to redistribute the losses, bank will charge a higher interest rate on the loans and lower rates on deposits.
Bad loans imply redirecting of funds from good projects to bad ones. Hence, the economy suffers due to loss of good projects and failure of bad investments.
When bank do not get loan or interest payments, liquidity problems may ensue.
The banks may face a serious liquidity crunch when a large number of borrowers fail to pay interest.
Bank shareholders are adversely affected.
Preventive Measures for avoiding case of NPAs
Proper credit assessment of borrowers should be completed to avoid NPA cases. Credit risk should be assessed properly for each corporate which approaches the banks for loans. There are mainly 4 types of risks which should be studied for the assessment purpose. These are:
Financial risk– The risk that a company does not have sufficient cash flow to meet all the financial obligations. It is the risk a shareholder bears when a company uses debt financing in addition to equity financing.
Industry risk– Risks companies face due to Industry related issues. It means if the industry is going through a slowdown, a particular firm cannot outperform in the market and will eventually suffer from it.
Business risk-The risk that a company will not have sufficient cash flows to meet its expenses on its operations. This means there are chances that the company will not have adequate cash to carry out day to day operations.
Management risk-The risks associated with ineffective, destructive and a non-performing management, which can hurt shareholders and the company and fund being managed.
The top 2 risks are objective in nature and they can be studied by the financial /annual reports of the corporate borrowers as well as the research reports . But as far as the bottom 2 risks are concerned, they are subjective in nature and should be assessed with help of in depth analysis for better precision. The credit risk assessment exercise would be repeated annually for the risk grades under the acceptable levels of credit risk and biannually for others for assessing grades as per assessment.