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Non-Performing Assets (NPA)

Non-Performing Assets (NPA) is an oxymoron! If it is non-performing, it is hardly an asset.

Typically NPA refers to sticky and potentially non serviced loans in its balance sheet. Billions of rupees are said to be NPA in Banks’ balance sheets. But the story does not end there. The real non-performing asset sits in the borrower’s balance sheet. So assuming that the bank has taken on an average 50% margin for lending, the real problem if NPA in the economy is at least TWICE the size of bank NPAs.

How did we end up there in the first place?

Asset Performance

Dr. Anil Lamba, an evangelist for financial literacy, says it simply that there is a corresponding liability for every asset, and for every liability, there is a cost. This is a cardinal rule. Every institution has to generate enough money using its assets to service this cost.

In fact, the assets need to produce much more than the cost of funds. Most of the NPAs are due to the inability to repay the principal obligation. So, entrepreneurs must remember that the mere profit-making to take care of interest is NOT enough. The cash generation has to be enough to service the loan repayment as well. This is mostly forgotten, and financial models are prepared to address the magic words of MPBF and DSCR (Debt Service Cove Ratio representing the amount of cash required to service interest and repayment obligations). The real issue is that the actual cash flows do not come anywhere close to the DSCR.

So entrepreneurs have to be careful in choosing the mix of the source of funds between own funds and third-party funds and the timing obligation on the repayment of principal on third party funds. They also have to be careful in the quality of assets for the funds deployed and the cash generation capacity of the assets.

Assets need to perform not just for the interest but the repayment of principal. Then there is the return for the Shareholders. Typically the demand on earning rate from assets is upwards of 70% during the prime years. What is your story?

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