Say an individual cannot pay his loan due to the fact that he lost his job or a company cannot repay loans due to perennial labor problems.
If the principal and interest is not paid for three consecutive months or 90 days, then it becomes a non performing asset for a bank or financial institution.
Over the last several quarters public sector banks in India have seen a sharp deterioration in their asset quality or what is called rising NPAs or non performing assets. Some have reported gross non performing assets of as high as 3 and 4 per cent, as the economic slowdown in India affected corporate performance. Also, a large number of non performing assets comes from the power and the infrastructure sector to which banks have lent.
Eventually, non performing assets if they continue to see no hopes of payment would have to be written off.
Recently, the Reserve Bank of India (RBI) began checking the readiness of Indian banks against any eventuality and also sought all possible information on adequacy of collateral and securities on corporate loans.
Banks have been making all efforts to recover their loans so as to reduce their non performing assets.
However, at times circumstances are acute that banks have to take a hit. In fact, risk is an inherent characteristic of a bank, which cannot be mitigated at times. For example, there are several banks that have had exposure to Kingfisher Airlines. The airline is now almost grounded and there is very little room for the company to pay back its loans. Under such circumstances banks with exposure to Kingfisher will be forced to take a hit, which will result in a rise in their non performing assets.