Asset Quality in Banks and various factors affecting it

In banking terminology, assets of a bank include all the different types of loans that it gives to borrowers and other investments made by the bank in relatively risk-free instruments such as government bonds, corporate bonds, etc.

The term asset quality implies the quality of loans that a bank has given out. A bank is said to have good quality assets if loans given out by it are being repaid on time. Bad quality assets include loans that are not being paid on time. An important measure of the asset quality of banks is the metric Non Performing Assets (NPAs). NPAs are loans in which the interest, instalment or principal have not been repaid for more than 180 days. Thus, a higher proportion of NPA implies worse asset quality of a bank. RBI has recently estimated in one of its working papers that gross NPAs in Indian banking sector could be 4.4% of total loans given out by Mar end 2014.

The most important reasons for rising NPAs have been insufficient appraisal of loan proposals and also inadequate monitoring of the loans given out. Aggressive lending by banks to big corporate houses is also to be blamed.

There are various macroeconomic factors that impact asset quality of banks. Low economic growth, less exports due to a weak global economy, delay in granting administrative clearance to infrastructure and industrial projects are a few macroeconomic factors that lead to deterioration in asset quality. A sharp fall in currency exchange rates also causes importers to default on loans.

In India, all of the above factors have contributed to rising NPAs. Public sector banks contribute to the bulk of NPAs though the share of private banks, both domestic and foreign, is also increasing in recent times. A recent working paper of RBI also pointed that coal and textile sector were the predominant sectors contributing to the recent deterioration in asset quality.