EFFECTS OF NPA ON BANKS AND FINANCIAL

INSTITUTIONS

A research submission submitted in fulfilment for the course (Law of Banking and
Finance) for attaining the degree B.A., LL.B (Hons.) during the Academic year 2021-
22.

A Submission made by Priti Guide

Roll-1953
B.A., LL.B (Hons.)

A Submission submitted to Mr. Abhishek Kumar

Chanakya National Law University, Nyaya nagar, Mithapur Patna-800001

March, 2022

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 DECLARATION BY THE CANDIDATE

I hereby declare that the work reported in the B.A., LL.B. (Hons.) Project Report
entitle “EFFECTS OF NPA ON BANKS AND FINANCIAL INSTITUTIONS”

Submitted at Chanakya National Law University, Patna is an authentic record

of my work carried out under the supervision of Mr. Abhishek Kumar. I have not
submitted this work elsewhere for any other degree or diploma. I am fully
responsible for the contents of my Project Report.

(Signature of the Candidate)

PRITI GUIDE

ROLL NO- 1953

B.A., LL.B. (Hons.), 8th SEMESTER

Chanakya National Law University, Patna

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 ACKNOWLEDGEMENT

Any project completed or done in isolation is unthinkable. This project, although prepared by
me, is a culmination of efforts of a lot of people. Firstly, I would like to thank our Professor Mr.
ABHISHEK KUMAR for, helping me in making the project on “EFFECTS OF NPA ON
BANKS AND FINANCIAL INSTITUTIONS” for his valuable suggestions towards the
making of this project.

Further to that, I would also like to express my gratitude towards our seniors who did a lot of
help for the completion of this project. The contributions made by my classmates and friends are,
definitely, worth mentioning.

I would like to express my gratitude towards the library staff for their help also. I would also like
to thank the persons asked for help by me without whose support this project would not have
been completed.

I would like to express my gratitude towards the Almighty for obvious reasons. Moreover,
thanks to all those who helped me in any way be it words, presence, Encouragement or blessings.

PRITI GUIDE

ROLL NO- 1953

B.A., LL.B. (Hons.), 8th SEMESTER

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4|Page
 TABLE OF CONTENTS

SERIAL PAGE
NAME OF CHAPTERS
NO. NO.

1. OBJECTIVE OF THE STUDY 7

2. HYPOTHESIS 7

3. RESEARCH QUESTIONS 7

4. RESEARCH METHODOLOGY 7

CHAPTERISATION
1. INTRODUCTION.................... 5-6
2. BANKING STRUCTURE IN INDIA… 8-14
3. NON PERFORMING ASSETS (NPA) AND
5. ITS EFFECTS… .............................. 15-20
4. CONCLUSION AND
SUGGESTIONS… ........................ 21-22

BIBLIOGRAPHY… ..... 23

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 1. INTRODUCTION

A country‟s development can be better perceived through economic growth which is influenced
by the prevailing financial system. The „Financial System‟ plays a crucial role and it
intermediates between the flow of funds belonging to those who save a part of their income and
those who invest in productive assets. A strong financial system is crucial to fulfill the objective
of strengthening the real economy and for its healthy and orderly growth.
Financial Institutions are intermediaries that mobilize savings and facilitate the allocation of
funds from surplus units to deficit unit in an efficient manner. Good financial institutions are
vital to the functioning of an economy. If finance were to be described as the articulatory
systems of the economy, financial institutions are its brain. They make decisions that tell scarce
capital where to go and ensure that it is used most efficiently. The process of financial
intermediaries support increasing the capital accumulation though the institutionalization of
savings and investment and as such, fosters economic growth. The gains to the real sector of the
economy therefore depend on how effectively the financial sector performs this basic function of
financial intermediation.
The financial systems of most developing countries are characterized by coexistence and co-
operation between the formal and informal financial sectors. The Indian financial system can
also be broadly classified into formal (organized) financial system and informal (unorganized)
financial system. Banking institutions are creators and purveyors of credit. While the liabilities
of banks are part of the money supply, this many not be true of non-banking financial
institutions. There is no hard and fast rule to distinguish between banking and non-banking
institutions.
Banks play a very useful and dynamic role in the economic life of every modern state: They are
important constituents of the money market and their demand deposits serve as money in the
modern community. Banks can work as catalytic agents of growth by following the right kind of
policies in their working, depending upon the socioeconomic conditions prevailing in a countr y.
It is realized that since banks have the required investment potentiality, they can make a
significant contribution in eradicating poverty, unemployment, and they can bring about
progressive reduction in inter-regional, inter-state, and inter sectoral disparities through rapid
expansion of banking services.

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Commercial banks have come to play a significant role in the development of countries. The two
basic functions of commercial banks are: mobilization of the savings of the people and
disbursement of credit according to socio-economic priorities, thus accelerating the pace of
economic development in the desired direction. The world over, banking system is the focal
point in the financial set-up of any developing country. In India too economic development has
evolved around the banking system.
NPA‟s Non-performing assets are the assets of the banks which are not performing, banks to run
the economy also provide short-term and long-term loans to the industries, individuals, farmers,
a bank also gives loan against the home, vehicles and many more. In some cases, the borrower
unable to pay the interest amount on time as well as unable to return the principal amount too, in
that case, bank declares that amount as nonperforming. NPA are considered as big problem in
the present days. The objective of the study is to find the level of non-performing assets of
banking sector in India and the impact of non-performing assets on profitability and financial
performance of banks in India. This study identified that public sector banks have highly affected
than private sector banks due to non performing assets in India and the increasing level of NPAs
impact the profitability of the banks.

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OBJECTIVES OF THE STUDY:

The researcher aims to do a critical analysis to explore the NPA of the banking sector and how it
affects the economy and the negative role played by the businesses in the growth of NPA with
the help of case laws/acts.

HYPOTHESIS:
The Researcher presumes that there is no significant impact of NPAs on profitability of Banks.

RESEARCH QUESTIONS
1. How has the Indian Banking System evolved?
2. What is the structure of the Indian Banking System?
3. What is Non-Performing Asset (NPA) and what are the causes for incidences and trends
of NPAs in the banks?
4. What are the major problems faced by banks due to NPAs?

RESEARCH METHODOLOGY:
The researcher will be relying on Doctrinal method of research to complete the project. These
involve various primary and secondary sources of literature and insights. The researcher has
made extensive use of the on-line sources of the Chanakya National Law University and also
other relevant internet sources.
METHOD OF WRITING
The method of writing followed in the course of this research paper is primarily analytical.

SOURCES OF DATA
 CASE LAWS
 BLOGS AND ARTICLES/JOURNALS.
 BOOKS
 CASE COMMENATRIES

LIMITATIONS OF THE STUDY:

 The researcher has territorial and time limitations in completing the project.

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 2. BANKING STRUCTURE IN INDIA

The existing banking structure in India, evolved over several decades, is elaborate and has been
serving the credit and banking services needs of the economy. There are multiple layers in
today's banking structure to cater to the specific and varied requirements of different customers
and borrowers. The banking structure played a major role in the mobilisation of savings and
promoting economic development. In the post financial sector reforms (1991) phase, the
performance and strength of the banking structure improved perceptibly. Financial soundness of
the Indian commercial banking system compares favourably with most of the advanced and
emerging countries.

In the past three decades, India's banking system has earned several outstanding achievements to
its credit. The most striking is its extensive reach. It is no longer confined to metropolises or
cities in India. In fact, Indian banking system has reached even to the remote corners of the
country. This is one of the main aspects of India's growth story. The government's regulation
policy for banks has paid rich dividends with the nationalization of 14 major private banks in
1969. Banking today has become convenient and instant, with the account holder not having to
wait for hours at the bank counter for getting a draft or for withdrawing money from his account.

Definition of Bank:

Section 5(b)1 defines bank as accepting for the purpose of lending or investment of deposits of
money from the public, repayable on demand or otherwise and withdrawal by cheque, draft, and
order or otherwise. Section 49A of the Act prohibits any institution other than a banking
company to accept deposit money from public withdrawal by cheque. Students may note that the
essence of banking business is the function of accepting deposits from public with the facility of
withdrawal of money by cheque. In other words, the combination of the functions of acceptance
of public deposits and withdrawal of the money by cheques by any institution cannot be
performed without the approval of Reserve Bank.

1
Banking Regulation Act, 1949

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Scheduled Bank:

Scheduled Banks are those banks which are listed in the Second Schedule to the Reserve Bank of
India Act, 1934. The Banks satisfying the following conditions are only included in the Second
Schedule.

(a) That the Bank‟s paid up capital plus free reserves are not less than Rs. 5.00 lakh, and

(b) That the affairs of the Bank are not conducted to the detrimental interest of the depositors.

The Reserve Bank also has powers to de schedule a bank, when the abovementioned conditions
are not satisfied. It may be noted presently, the RBI has prescribed a minimum capital of Rs. 100
crores for starting a new commercial bank.

Classification of Banks:

Today is the age of specialization and we can find specialization in all fields including banking.
The banks have specialized in a particular line of finance. Various types of banks have
developed to suit the economic development and requirements of the country.

The principal banking institutions of a country may be classified into following types:

(1) Central Banks: Central Bank is the bank of a country – a nation. Its main function is to issue
currency known as „Bank Notes‟. This bank acts as the leader of the banking system and money
market of the country by regulating money and credit. These banks are the bankers to the
government; they are banker‟s banks and the ultimate custodian of a nation‟s foreign exchange
reserves. The aim of the Central Bank is not to earn profit, but to maintain price stability and to
strive for economic development with all round growth of the country.

(2) Commercial Banks: A bank, which undertakes all kinds of ordinary banking business, is
called a commercial bank. Industrial Banks or Financial Institutions: An Industrial Bank is one
which specializes by providing loans and fixed capital to industrial concerns by subscribing to
share and debenture issued by public companies.

(3) Industrial or Development Banks: It is an Indian government-owned financial service

company. It was established in 1964 to provide credit and other financial facilities for the
development of Indian industry. Its vision is to be a highly preferred and reliable bank enhancing
value for all stakeholders.

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(4) Exchange Banks (authorized dealers in foreign exchange): These types of banks are primarily
engaged in transactions involving foreign exchange. They deal in foreign bills of exchange
import and export of bullion and otherwise participate in the financing of foreign trade.

(5) Co-operative Banks: They are organized on co-operative principles of mutual help and
assistance. They grant short-term loans to the agriculturists for purchase of seeds, harvesting and
for other cultivation expenses. They accept money on deposit from and make loans to their
members at a low rate of interest.

(6) Land-mortgage Banks (Presently known as Agriculture and Rural Development Banks):
They are agriculture development banks. The Land-mortgage banks supply long-term loans for a
period up to 15 years for development of land to improve agricultural yields. They grant loan for
permanent improvements in agricultural lands. The National Bank for Agriculture and Rural
Development (NABARD) was constituted by the Government to promote rural development.

(7) Indigenous Banks: The Central Banking Enquiry Commission defined an indigenous banker
as an individual or film accepting deposits and dealing in indigenous lending of money to the
needy. They form unorganized part of the banking structure, i.e., these are unrecognized
operators in receiving deposits and lending money.

(8) Savings Banks: These are institutions which collect the periodical savings of the general
public. Their main object is to promote thrift and saving habits among the middle and lower
income sections of the society.

(9) Supranational Banks: Special Banks have been created to deal with certain international
financial matters. World Bank is otherwise known as International Bank for Reconstruction and
Development (IBRD) which gives long-term loans to developing countries for their economic
and agricultural development. Asian Development Bank (ADB) is another Supranational Bank
which provides finance for the economic development of poor Asian countries.

(10) International Banks: Banks are those which are operating in different countries. While, the
registered office/head office is situated in one country, they operate through their branches in
other countries. They specialize in Banking business pertaining to foreign trade like opening of
letters of credit, providing short-term finance in foreign currency, issue of performance
guarantee, arranging foreign currency credits, etc. They are the main traders in International
Currencies like US 'dollars', Japanese 'Yen', the new-born European Currency 'Euro', etc.
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Structure of Banking Sector in India:

The Indian banking system has emerged as a sluggish business institution to a highly proactive
and dynamic entity. It is highly fragmented with 30 banking units contributing to almost 50
percent of deposits and 60 percent of advances. India‟s banking system mainly consists of “non-
scheduled” banks and “scheduled banks”. Scheduled banks refer to those that are included in the
Second Schedule of the Banking Regulation Act of 1965 and satisfy the twin conditions that a
bank must have paid-up capital and reserves of not less than Rs. 500,000 and secondly satisfy the
Reserve Bank of India (RBI) as its affairs are not conducted in a manner detrimental to the
interests of its depositors. Scheduled banks consist of scheduled commercial banks and
scheduled cooperative banks. The former are divided into four categories: (i) public sector banks
(which are further classified as nationalised banks and State Bank of India [SBI] banks); (ii)
private sector banks (which are further classified as old private sector banks and new private
sector banks that emerged after 1991); (iii) foreign banks in India; and, (iv) regional rural banks
(which operate exclusively in rural areas to provide credit and other facilities to small and
marginal farmers, agricultural workers, artisans, and small entrepreneurs).2 Non-scheduled banks
are those banks which does not come under the Schedule of the Banking Regulation Act of 1965
and, thus, do not satisfy the conditions laid down by that schedule. Nonscheduled banks are
further divided into two classifications non-scheduled cooperative banks and non-scheduled
commercial banks. The scheduled commercial banks with the exception of foreign banks are
registered in India under the Companies Act. The SBI banks consist of eight independently
capitalised banks: seven associate banks, and SBI itself.3
The SBI is the largest commercial bank in India in terms of assets, deposits, branches, and
employees and has 13 head offices governed each by a board of directors under the supervision
of a central board. It was originally established in 1806 when the Bank of Calcutta (latter called
the Bank of Bengal) was established, and then amalgamated as the Imperial Bank of India after
merger with the Bank of Madras and the Bank of Bombay. The shares of Imperial Bank of India
were sold to the RBI in 1955. Nationalised banks refer to private sector banks that were
nationalised (14 banks in 1969 and six in 1980) by the Central Government. Unlike SBI,

2
Government of India, (1951), “First Five Year Plan”, Vol. I, Planning Commission, New Delhi.
3
RBI (1985), Report of the Chakravarty Committee to Review the Working of Money Market,
Mumbai, p. 88.

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nationalised banks are centrally governed by their respective head offices. Thus, there is only
one board for each bank and meetings are less frequent. In 1993, Punjab National Bank merged
with another nationalized bank, New Bank of India, so the number of nationalized banks fell
from 20 to 19. Regional rural banks account for only 4 percent of total assets of scheduled
commercial banks. Scheduled cooperative banks are further divided into scheduled urban
cooperative banks and scheduled state cooperative banks. As at the end of March 2010, the
number of scheduled banks is as follows: 19 nationalized banks, eight SBI banks, 23 old private
sector banks, 8 new private sector banks, 38 foreign banks, 82 regional rural banks, 53 urban
cooperative banks, and 31 state cooperative banks.

Reserve Bank of India (RBI) the RBI is India‟s central bank. The RBI was established on April
1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934. RBI acts as a
banker to the Government and Banks. The Central Bank maintains record of Government
revenue and expenditure under various heads. It maintains deposit accounts of all other banks
and advances money to other banks, when needed. Another important function of the Central
Bank is the issuance of currency notes, regulating their circulation in the country by different
methods. Banks in the country are broadly classified as scheduled banks and non-scheduled
banks.

Scheduled Banks:

All banks which are included in the Second Schedule to the Reserve Bank of India Act, 1934 are
scheduled banks. These banks comprise Scheduled Commercial Banks and Scheduled
Cooperative Banks. These banks are eligible for certain facilities such as financial
accommodation from RBI and are required to fulfill certain statutory obligation. The RBI is
empowered to exclude any bank from the schedule whose: (1) Aggregate value of paid up capital
and reserves fall below Rs 5 lakh (2) Affairs are conducted in a manner detrimental to the
interests of depositors (3) Goes into liquidation and ceases to transact banking business.

Commercial Banks:

Commercial banks may be defined as, any banking organization that deals with the deposits and
loans of business organizations. Commercial banks issue bank checks and drafts, as well as
accept money on term deposits. Commercial banks also act as moneylenders, by way of

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installment loans and overdrafts. Commercial banks also allow for a variety of deposit. These
institutions are run to make a profit and owned by a group of individuals.

Public Sector Banks:

These are banks where majority stake is held by the Government of India. Foreign Banks These
banks are registered and have their headquarters in a foreign country but operate their branches
in our country.

Private Sector Banks:

These are banks majority of share capital of the bank is held by private individuals. These banks
are registered as companies with limited liability.

Regional Rural Banks:

Regional Rural Banks were established under the provisions of an Ordinance promulgated on the
26th September 1975 and the RRB Act, 1976 with an objective to ensure sufficient institutional
credit for agriculture and other rural sectors. The area of operation of RRBs is limited to the area
as notified by Government of India covering one or more districts in the state. RRBs are jointly
owned by Government of India, the concerned State Government and Sponsor Banks (27
Scheduled commercial banks and one State Cooperative Bank); the issued capital of a RRB is
shared by the owners in the proportion of 50%, 15% and 35% respectively. Prathama bank is the
first Regional Rural Bank is India located in the city Moradabad in Uttar Pradesh.

Cooperative Banks:

A cooperative bank is a financial entity which belongs to its members, who are at the same time
the owners and the customers of their bank. Cooperative banks are often created by persons
belonging to the same local or professional community or sharing a common interest. Co
operative banks generally provide their members with a wide range of banking and financial
services (loans, deposits, banking and accounts, etc.). They provide limited banking products and
are specialists in agriculture-related products. Cooperative banks are the primary financers of
agricultural activities, some small-scale industries and self employed workers. Cooperative
banks function on the basis of “no profit no-loss”. Anyonya Co-operative Bank Limited (ACBL)
is the co-operative bank in India located in the city of Vadodara in Gujarat.

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The Co-operative Credit system consists of:

a. Short-term agricultural credit institutions

b. Long-term agricultural credit institutions

c. Non-agricultural credit institutions

Export-Import Bank of India (EXIM BANK) Export-Import Bank of India is the premier export
finance institution of the country, established in 1982 under the Export-Import Bank of India
Act, 1981.

Industrial Development Bank of India (IDBI):

The Export-Import Bank of India (IDBI) was established on 1 July 1964 under an Act to
Parliament as wholly owned subsidiary of the Reserve Bank of India. In 16 February 1976, the
ownership of IDBI was transferred to the Government of India and it was made the principal
financial institution for coordinating the activities of institutions engaged in financing, promoting
and developing industry in the country.

National Bank for Agriculture and Rural Development (NABARD):

NABARD is an apex development bank in India having headquarters based in Mumbai

(Maharashtra)and other branches are all over the country. It was established on 12 July 1982 on
the recommendations of Shivaram Committee, by an act of parliament on 12 July 1982 to
implement the National Bank for Agriculture and Rural Development Act 1981.

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 3. NON PERFORMING ASSEST (NPA) AND ITS EFFECTS

A Non-performing asset (NPA) is defined as a credit facility in respect of which the interest
and/or installment of Bond finance principal has remained „past due‟ for a specified period of
time. In simple terms, an asset is tagged as non performing when it ceases to generate income for
the lender. Nonperforming assets, also called non-performing loans, are loans, made by a bank or
finance company, on which repayments or interest payments are not being made on time.
The concept of Non-Performing Assets (NPAs) was introduced for the first time in the
Narasimham Committee on “Financial System Reforms” that was tabled in Parliament on
December 17th 1991. The Committee studied the prevailing financial system, identified its short
comings and weaknesses and made with ranging suggestions and recommendations in line with
internationally accepted norms. Based on the recommendations of the Committee on “Financial
System Reforms”, the RBI evolved prudential norms on Income recognition, Asset classification
and Provisioning and issued revised instructions to banks in April 1992. While conveying non-
performing category and their anxiety to present rosy picture of their affairs the above
instructions to banks also advised them that as per practice followed internationally, income on
NPAs is not to be recognized on accrual basis but is to be looked only when it is actually realized
because an asset becomes non-performing when it ceases to generate income. The above
instructions of RBI have since been implemented by banks from the financial year ended March
1998.1
Non-performing assets (NPAs) constitute integral part of banks' operations. A bank gives out
money upfront and earns income over a time on the promise of a borrower to repay. When loans
are not repaid, the bank loses both its income stream, as well as its capital. Lending is always
accompanied by the credit risk arising out of the borrower‟s default in repaying the money. The
level of non-performing loans is recognized as a critical indicator for assessing banks' credit risk,
asset quality and efficiency in allocation of resources to productive sectors. The most calamitous
problem facing commercial banks all over the world in recent times is spiraling non-performing
assets which are affecting their viability and solvency and thus posing challenge to their ultimate
survival. So the problem of NPAs should be nipped in the bud. It is possible only if the check is
placed on NPAs from the very beginning.

1
http://www.researchandmarkets.com/reports/4020/indian_banking_industry
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Types of NPA:

Gross NPA:

Gross NPA (non-performing asset) refers to overall quantity of loans that have gone bad debts. It
consists of all the nonstandard assets like as sub-standard, doubtful, and loss asset. Gross NPA is
a non standard asset, on which bank has made provisions, and which is still held in banks‟ books
of account.

“Gross NPAs Ratio = Gross NPAs / Gross Advances”

Net NPA:

Net NPAs are those advances which are obtained after deducting the provisions from Gross
NPA. Net NPA shows the actual burden of banks. The banks have to make certain provisions
against the NPA‟s according to the RBI guidelines.

“Net NPAs = Gross NPAs – Provisions / Gross Advances – Provisions”

Assets Classification:

Standard Assets:

Standard Asset means which assets are not facing the problem and not more risk towards
customer. Such assets are assumed to be performing asset. A general provision of 0.25% has to
be provided on global loan portfolio basis.

Sub-standard Assets:

An asset would be classified as sub-standard if it remained NPA for a period less than or equal to
12 months.

Doubtful Assets:

These are the assets which have remained NPAs for a period exceeding 12 months and which are
not considered as a loss advance.

Loss Assets:

An asset that is an NPA for a period of more than 36 months and the loss is identified by the
bank through the internal or external auditor or by the central bank inspectors. The amount has
not been written off wholly or partly.

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 Causes for Non Performing Assets:

A strong banking sector is important for a flourishing economy. The failure of the banking sector
may have an adverse impact on other sectors. The Indian banking system, which was operating
in a closed economy, now faces the challenges of an open economy. One of the main causes of
NPAs into banking sector is the directed loans system under which commercial banks are
required a prescribed percentage of their credit (40%) to priority sectors. As of today nearly 7
percent of Gross NPAs are locked up in „hard-core‟ doubtful and loss assets, accumulated over
the years.

The factors for NPA are:

Internal Factors:

1. Funds borrowed for particular purpose are not utilized for the same

2. Defective lending process: There are three principles that are followed by the commercial
banks in lending process i.e. principle of safety, principle of liquidity, principles of profitability.
Principle of safety means that the borrower is in position to pay back the loan. Therefore the
banker should take utmost care in ensuring that the enterprise or business for which a loan is
sought is a sound one and the borrower is competent of carrying it out successfully, he should be
a person of integrity and good character.

3. Inappropriate technology: Due to improper technology and management information

system, market driven decisions on real time basis cannot be taken. So, all the branches of the
banks should be upgraded with current scenario.

4. Improper SWOT analysis: The inappropriate strength, weakness, opportunity and threat
analysis is another reason for increase in NPA‟s, so the bank should examine the profitability,
viability, long term acceptability of the project while financing.

5. Poor credit appraisal system: Due to poor credit appraisal the bank gives advances to those
who are not able to repay it back. As a result the NPA‟s of the bank increases. So the bank
should maintain proper credit appraisal system. 2

6. Managerial deficiencies: The banker should always select the borrower very cautiously and
should take tangible assets as security to safeguard its interests. The banker should follow the

2
http://www.elearnmarkets.com
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principle of diversification of risks which means that the banker should not grant advances to a
few big firms only or to concentrate them in few industries or in few cities.

7. Absence of regular follow up: The irregularities in spot visit also increase the NPA‟s, the
absence of regular visit of bank officials to the customer point decreases the collection of interest
and principal on the loan.

8. Incomplete and faulty documentation: There should thorough verification by the officials
on the documents submitted by the borrowers.

External Factors:

1. Ineffective recovery tribunal: The government has set of number of recovery tribunals,
which works for recovery of loans and advances, due to their carelessness and ineffectiveness in
their work the bank suffers the consequence of non-recovery, thereby reducing their profitability
and liquidity.

2. Willful Defaults: The Indian Public Sector Banks are worst hit by these defaults. It is a
default in repayment obligation.

Ex: Kingfisher Airlines Ltd. Is one among many of those willful defaulters, Others are Beta,
Napthol, Winsome Diamonds & Jewellery Ltd., Rank Industries Ltd., XL Energy Ltd. etc.

3. Natural calamities: This is the measure factor, which is creating alarming increase in NPA‟s
of the PSBs. Basically our farmers depends on rainfall for cropping due to irregularities of
rainfall the farmers are unable to attain the production level and thus they are unable to repay the
loans. So the banks has to make large amount of provisions in order to pay those loans

4. Industrial sickness: Inappropriate project handling, ineffective management, lack of adequate

resources, lack of advanced technology, day to day change in government policies produce
industrial sickness therefore the banks that finance those industries end up with a low recovery
of their loans, by reducing their profit and liquidity.
5. Lack of demand: Entrepreneurs in India could not predict their product demand and starts
production which ultimately piles up their product. Thus, making them unable to payback the
money they borrow to operate these activities. Therefore the banks record the non recovered part
as NPA‟s and has to make provision for it.

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Effects of NPA:

The following are the some of the major problems faced by banks due to NPA‟s:

1) Effect of Profitability of Banks: As NPA‟s cease to generate income for the banks it will
reduce the net interest income of the banks. As NPA‟s goes on increasing, the net income of the
banks will decrease.

2) Increase in provisions of banks: RBI has introduced prudential norms for income
recognition and asset classification for Indian banks and financial institutions, to ensure proper
provisioning and transparency in the published accounts. In agreement with the prudential norms
of RBI, banks need to provide provision on Non- Performing Assets. The provisions are made by
banks on the basis of classification of assets into Non-Performing Assets.

3) Liquidity position: NPA‟s affects the liquidity position of the banks, thereby creating a miss-
match between assets and liquidity and force the banks to raise resources at high cost. The
increased NPAs may pose liquidity issues which is likely to lead run on bank by depositors.

4) Effect on MSMEs: The disbursement of loans mainly with the large scale firms, this made
banks reluctant to issue loans to small scale industries. So MSME suffer from lack of funds from
the banks and has to borrow from other sources which would increase their cost of capital.

5) Shareholders’ confidence: Normally, shareholders are interested to enhance value of their

investments through higher dividends and market capitalization which is possible only when the
bank posts significant profits through improved business. The increased NPA level is likely to
have adverse impact on the bank business as well as profitability thereby the shareholders do not
receive a market return on their capital and sometimes it may erode their value of investments.

Example: Share price of Punjab National Bank.

6) Burden to Government: Since the Government is the majority shareholder in the public
sector banks, it has to provide equity capital, if the banks are struggling. As NPA‟s are
increasing PSB‟s are struggling, so the government needs to provide capital to the banks.

7) Higher cost of capital: It shall result in increasing the cost of capital as banks will now have
to keep aside more funds for the smooth working of its operations. To generate income and meet
the expenses the banks will increase the interest rates.

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 8) Declining productivity: Loans given by the banks are the assets to the banks. Since the
Assets (NPA‟s) of the banks ceases to generate income for the bank there will be decrease in the
income which leads to decrease in productivity of the bank‟s assets.

9) Asset (Credit) contraction: The increased NPAs put pressure on recycling of funds and
reduces the ability of banks for lending more and thus results in lesser interest income. It
contracts the money stock which may lead to economic slowdown.

10) Public confidence: Credibility of banking system is also affected greatly due to higher level
NPAs because it shakes the confidence of general public in the soundness of the banking system.

11) Ultimate burden on society: It will ultimately affect the consumer who now will have to
fetch out more money for paying higher interest. It will lead to lower growth and higher inflation
because of the higher cost of capital. 3

The Non-Performing Assets have always created a big problem for the banks in India. It is just
not only problem for the banks but for the economy too. The money locked up in NPAs has a
direct impact on profitability of the bank as Indian banks are highly dependent on income from
interest on funds lent. In a nutshell, the high incidence of NPA has cascading impact on all
important financial ratios of the banks viz., Net Interest Margin, Return on Assets, Profitability,
Dividend Payout, Provision coverage ratio, Credit contraction etc., which may likely to erode the
value of all stakeholders including Shareholders, Depositors, Borrowers, Employees and public
at large.

3
https://financialcontrol.in/non-performing-assets/

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 4. CONCLUSION AND SUGGESTIONS

Banking industry plays a major part in the development of economy of the country as it provides
the needs for all the segments of the society. The banking sector provides strength for the
country‟s financial system as it is involved in performing the functions such as liquidity and risk
management. The economies of the world have established by making use of the credits
availability. The country could have healthy economy based on the kind of banking system.

A bank is a financial institution that provides banking and other financial services to their
customers. A banker works within the financial system to provide loans, accept deposits, and
provide other services to their customers. They must do so within a climate of extensive
regulation, designed primarily to protect the public interests.

In this context it is to be noted that India has very large geographical area and population, it also
has huge no. of banks which are needed to be regulated to keep the economy stable. If the banks
are not regulated it would create imbalance in the economy. Regulatory regime over banking
companies means the regulation of control over banking companies. In India, banking companies
are regulated by Banking Regulation Act, 1949 and Reserve Bank of India Act, 1934.

One of the major problems for banking sector in India is Non-performing assets. NPA had shown
an impact on the Indian economy. The increasing level of NPAs impacted the profitability of the
banks and also the economy of the country. The factors in increasing the NPA are poor credit
management policies, intentional loan defaults, loans sanctioned without enquiry for agricultural
purposes. One of the reasons for increase in NPA is the aggressive credit policy of giving high
amount of loans. The recovery measures taken by government and banks are not effective in
solving the problem in bad debts. The banks and government should take proactive measures in
recovery process. The strict policies should be implemented for the large borrowers than the
small borrowers for solving this problem. Banks should identify and monitor the accounts of the
loans continuously that has the possibility in becoming Non performing. This problem of NPA
must be taken seriously or else this problem will badly effect the profitability of banks. Thus
leading to the decrease in the growth of economy in the country. The financial institutions and
banks must adopt structured and real world policies in prevention of Non-performing assets.

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Hypothesis of the Project that there is no significant impact of NPAs on profitability of
banks is found to be true.

This study reveals that a higher level of NPA in the portfolio of the banks has an adverse impact
on profitability of public banks. An NPA account not only reduces profitability of banks by
provisioning in the profit and loss account, but their carrying cost is also increased which results
in excess & avoidable management attention. Apart from this, a high level of NPA also puts
strain on a bank‟s net worth because banks are under pressure to maintain a desired level of
Capital Adequacy and in the absence of comfortable profit level, banks eventually look towards
their internal financial strength to fulfill the norms thereby slowly eroding the net worth. The
enormous provisioning of NPA together with the holding cost of such non-productive assets over
the years has acted as a severe drain on the profitability of the banks. NPA is not merely non
remunerative. It is also cost absorbing and profit eroding. The study reveals that the level of Non
Performing Assets (Credit Risk) has a significant negative influence on the profitability and
liquidity of banks. The NPAs do not generate interest income for banks but at the same time
banks are required to provide provisions for NPAs from their current profits. The negative
influence of the NPA to total advances is a critical variable that not only affect the profitability
of the banks but also can undermine the very existence of the banking sector. To improve the
efficiency and profitability of banks the NPA need to be reduced and controlled.

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 BIBLIOGRAPHY
BOOKS:

 Chaudhary, R.N., Banking Laws, Central Law Publication, Allahabad (6th Edition, 2018)
 Singh, Avtar, Banking and Negotiable Instruments, Eastern Book Company (4th Edition,
2108)
 L. Tannan, Tannan’s Banking Law & Practice in India, Lexis Nexis (4th Edition, 2018).
 Bangia, R.K., Banking La and Negotiable Instruments Act, Allahabad Law Agency (10th
Edition, 2019)

STATUTES REFERRED:

 The Banking Regulation Act, 1949

 The Reserve Bank of India Act, 1934

WEBSITES:

 http://www.indianmba.com/Faculty_Column/FC56/fc56.html
 https://www.livemint.com/Industry/csNs6m20dfbN1ZmBDdr2jL/Bank-gross-NPAsat-
Rs841-trillion-in-December-2019.html
 https://financialcontrol.in/non-performing-assets/
 https://blog.forumias.com/non-performing-assetsnpas-and-its-impact-on-indianeconomy/

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