IMPACT OF NPA
The health of a bank is reflected not only by the size of its balance sheet but also by the return on its assets. NPAs generate no interest income (Chaudhuri, 2002). The banks are required by law to provide for future loan losses arising from its bad assets (at a coverage of 70%), out of current profits.
This not only affects the profitability but also liquidity because now the bank has fewer funds to lend out or recycle. It further increases indirect costs. High NPAs degrade a bank’s credit rating, lowering its credibility as well as its ability to raise fresh capital (Indira & Vasishtha, (2001). The NPAs have deleterious impact on the return on assets in the following ways:1. The interest income of banks will fall and it
is to be accounted only on receipt basis.
2. Banks profitability is affected adversely because of the providing of doubtful debts and consequent to writing it off as bad debts.
3. Return on investments (ROI) is reduced.
4. The capital adequacy ratio is disturbed as NPAs enter into its calculation.
5. The cost of capital will go up.
6. Asset and liability mismatch will widen.
7. It limits recycling of the funds.