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Impact of Non-Performing Assets on Profitability: A Study of Selected Private

and Public Sector Banks in India

Article  in  The Empirical Economics Letters · January 2021

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The Empirical Economics Letters, 19 (Special Issue) (October 2020)
ISSN 1681 8997

Impact of Non-Performing Assets on Profitability: A Study

of Selected Private and Public Sector Banks in India
Ashish Kumar
University School of Management Studies
Guru Gobind Singh Indraprastha University, New Delhi, India
Email: ashish_prl@yahoo.com

Srirang K Jha*
Apeejay School of Management, New Delhi, India

Sahil Grover
Apeejay School of Management, New Delhi, India
Email: sahilgrover.asm@gmail.com

Abstract: Non-performing assets (NPAs) have plagued the Indian banking sector
for long. NPAs refer to a classification for loans or advances that are in default and
it is assumed that banks will not be able to recover anything from these accounts.
Indeed, the NPAs disrupt the regular cash flows of the banks. This study examines
the extent to which the NPAs affect the profitability of the banks in India. A
comparative scrutiny of leading private sector and public sector banks indicates
that the NPAs affect the profitability of the latter in a significant way. In the this
study, comparisons have been made between HDFC Bank and State Bank of India
(SBI). Results indicate that the provisions for NPA do impact the net profits of the
banks and if the provision for the bad debts is added to the net profit of the public
sector banks, they can be highly profitable. Hence, it is imperative for the public
sector banks to focus on reducing the NPAs under the constraints of priority sector
lending as mandated by the government. It was further observed that reduced
NPAs are likely to result in higher profitability of the banks, especially in the
context of public sector banks.
Keywords: Non-performing assets, Profitability, Banks, India
JEL Classification Number: G2, G3

1. Introduction
Indian economy is going through a recurrent slowdown. To uplift the economy, the
banking sector has a crucial role to play in terms of lending. The major problem of the
Indian banking system is lack of available funds which has created a situation of liquidity
crisis in the country as borrowers are not able to get funds. One of the reasons for this

*
Corresponding Author Email: jha.srirang@gmail.com
The Empirical Economics Letters, 19 (Special Issue) (October 2020) 130

problem can be attributed to the increasing percentage of NPAs. Majority of Indian banks
are suffering from this crisis, specifically the government-owned banks are hit the most.
The RBI data indicates that the public sector banks are a significant contributor towards
non-performing assets as compared to the private banks. Due to this, the financial health
of public sector banks is at higher risk. As a result, the credit growth of banks has been
severely impacted. India’s rate of conversion of advances to NPA is more significant when
compared with other emerging economies like China. India has to address the problem of
NPA immediately to boost the economy and achieve its target of becoming a $ 5-trillion
economy by 2024. Resolution of the NPA crisis is likely to enhance the savings and
investment capacity of the sector, which in turn may strengthen the banks in due course.
The primary focus of RBI and government policies is effective management of the NPAs
so as to salvage the banks before it is too late.
The problem of NPA crisis in India cannot be attributed to a single incident. It emerged as
a large scale issue during the mid-1990s after liberalization, privatization and
globalization, which changed the economic structure of the country drastically. The
banking sector discovered sudden stacking of bad loans (NPAs) during 1995. If we
observe the NPA data available on RBI’s website from the year 1995 (RBI, Statistical
Tables), it appears that the extent of non-performing assets has increased continuously
until the 2000s. The extent of NPAs increased at a high pace during the strong economic
growth between the periods of 2006-2008 as banks gave loans rapidly without maintaining
due diligence and performing proper checks to take advantage of the economic boom.
Still, the crisis happened in 2008, which resulted in quite the opposite.
The situation worsened further during the year 2011 as RBI took stringent measures to
deal with the problems caused by the crisis that happened earlier. Also, there was
depreciation in the rupee value, which profoundly affected the debt servicing ability of the
corporate sector. From 2015 through 2017, the quantum of NPAs kept on rising, and the
extent of gross NPAs reached at Rs.6,84,732 crores in March 2017 from Rs.2,79,016
crores in March 2015 (Kumar, 2020). This happened because many large projects of
companies to whom loans were given, got struck mainly due to issues related to raw
material supply and land acquisition. Despite many policies launched by the RBI to tackle
the situation, the NPAs kept on piling up and only got worse with time (Reserve Bank of
India, 2018). Furthermore, banking sector had shown improvement as its GNPA ratio had
declined from 11.2% in March 2018 to 9.1% in March 2019 (Ministry of Finance, Govt. of
India, 2019). The 4Rs strategy of Recognition, Resolution, Recapitalization and Reforms
initiated by the Ministry of Finance, Government of India, to improve the current situation
has indeed led to significant reduction of non-performing assets of the government-owned
banks.
The Empirical Economics Letters, 19 (Special Issue) (October 2020) 131

2. Review of Literature

Non-performing assets invariably affects profitability, liquidity and solvency position of

banks (Goel, 2018). Kalara (2012) observed that the significant factors responsible for
NPAs are legal system, change in government policies, poor selection of borrowers,
misallocation of credit, socio-political pressures, lack of information on borrowers and
willful defaults. It was further observed that the non-performing assets of government
banks are comparatively more than that of private sector banks (Parmar, 2014; Helge and
Eknath, 2016; Tayal et al., 2019). The public sector banks generally have higher Gross
NPA to total assets ratio, Net NPA to total assets ratio and gross NPA to gross advance
ratio and net NPA to the net advance ratio when compared with other banking sectors
(Nanda and Mahajan, 2007). It was observed that NPAs are acting as a performance
barrier for public sector banks (Chary and Fasi, 2019). No wonder, public sector banks in
India have performed poorly because of non-performing assets (Chakraborty, 2017).

Further, it has been observed that the damages triggered by NPAs may be offset by more
qualitative loans and careful scrutiny of the borrowers’ abilities to pay back (Ramandh and
Rajesham, 2013). Private sector banks manage their loan portfolios better and are
proficient in the controlling of their loan assets (D’Silva, 2012). The level of NPA is high
and can be reduced by the right credit assessment procedure, implementing an actual
internal control structure and also working towards the improvement of asset quality
(Balasubramaniam, 2012). Stringent guidelines may be enforced by the state to check the
piling up of non-performing assets (Manu and Maheshwari, 2018). Researchers have also
looked at the impact of non-performing assets on fluctuations in share prices of the
concerned banks. In some cases, rising non-performing assets have little influence on the
stock prices (Tayal et al., 2019). It was further observed that gross non-performing assets
did not have any effect on banks market capitalization in a significant way (Dubey and
Kumari, 2016).

This study therefore aims at examining the impact of NPAs on the profitability of selected
public and private sector banks by means of observing the change which is created by the
provision for NPAs in the net profit of the bank.

3. Methodology
Based on market capitalization, two leading banks, one from the private sector and one
from the public sector, have been selected for the analysis. The selected banks are HDFC
The Empirical Economics Letters, 19 (Special Issue) (October 2020) 132

Bank (Private Sector) and State Bank of India (SBI) (Public Sector). The secondary data
related to net profit and provisions for NPA have been collected from the standalone
financial statements of the banks from their respective websites. The data has been
collected for eight years, from 2012 to 2019. The data has been analyzed by way of tabular
and graphical representations.
4. Data Analysis and Interpretations
4.1. HDFC Bank (Private Sector Bank)

Table 1 represents the data for HDFC Bank for the year 2012-2019. This table depicts the
net profit inclusive of provisions for NPA as well as excluding the provisions for NPA
along with the provisions provided by banks for NPA (Rs. in Cr.). This table also analyses
the percentage change in Net profit with and without NPA provisions that shows a
substantial increase if we add the NPA provisions to the bank profit. On analyzing the
data, we observe that as the provisions for NPA are rising, they are creating a negative
impact on the profit for the year, that is, there is an inverse relationship between provisions
for NPA and profit for the year. This relationship is observable by studying the changes in
the columns “Net Profit for the year – Provision for NPA”, “Provisions for NPA” and
“Net Profit for the year + Provision for NPA”. It also proves the indirect relationship
between the NPA and the profitability since provisions for NPA are created based on the
quality and quantity of NPA that the bank has.
Table 1: HDFC Bank (Figures in Crores)
HDFC BANK – Standalone
2012 2013 2014 2015 2016 2017 2018 2019
Net Profit for the year 5167.1 6726.3 8478.38 10216.3 12296.33 14550.2 17487.3 21078.17
– Provision for NPA
Provisions for NPA 1091.78 1234.21 1632.58 1723.58 2133.63 3145.3 4910.43 6394.11
Percentage Change in 30.18 26.05 20.50 20.36 18.33 20.19 20.53
Net Profit
Percentage Change in 13.05 32.28 5.57 23.79 47.42 56.12 30.21
NPA Provisions
Net Profit for the year 6258.88 7960.51 10111 11939.9 14429.96 17695.5 22397.73 27472.28
+ Provision for NPA

Data represented in Figure 1 shows the comparison among Net profit for the year with and
without NPA, this shows a huge difference and will add onto the profitability.
The Empirical Economics Letters, 19 (Special Issue) (October 2020) 133

Figure 1: Trends regarding net profits and provisions for NPA vis-à-vis HDFC Bank

30000
25000
20000
Rs (Crores)

15000
10000
5000
0
2012 2013 2014 2015 2016 2017 2018 2019
Net Profit for the year - Provision
for NPA 5167.1 6726.3 8478.38 10216.312296.3314550.2 17487.321078.17

Net Profit for the year +

Provision for NPA 6258.88 7960.5110110.9611939.8814429.9617695.522397.7327472.28

Figure 2: Percentage increase in Net Profit over the years considering NPA as non-
factor vis-à-vis HDFC Bank

35.00 30.34
28.08
30.00
25.00 21.13 21.62
18.35 19.26
20.00 16.87 17.35

15.00
10.00
5.00
0.00
2012 2013 2014 2015 2016 2017 2018 2019
Percentage Increase in
profit over the years 21.13 18.35 19.26 16.87 17.35 21.62 28.08 30.34

The trend line as per Figure 1 shows the percentage increase in the overall net-profit if we
add the amount of the provisions for NPA to the net profit of bank per yearly basis (2012-
2019). This trend line shows the years in consideration. We can see that the profit would
have increased by 21.13 % in 2012, 18.35 % in 2013, 19.26 % in 2014, 16.87 % in 2015,
17.35 % in 2016, 21.62 % in 2017, 28.08 % in 2018, and 30.34 % in 2019 (Figure 2 ). The
The Empirical Economics Letters, 19 (Special Issue) (October 2020) 134

net profits would have increased for the banks by this massive percentage, which would
have been used for the bank’s development and added more fuel to the economy.

4.2. State Bank of India (Public Sector Bank)

Table 2 represents the data for State Bank of India for the year 2012-2019, this table
depicts the net profit inclusive of provisions for NPA as well as excluding the provisions
for NPA along with the provisions provided by banks for NPA (Rs. in Crore), the table
also analyses the percentage change in Net profit with and without NPA provisions that
shows a tremendous increase if we add the NPA provisions to the bank profit. There exists
an inverse relationship between the provisions for NPA and net profit for the year, as we
observed in the case of HDFC bank. However, there is a difference in the extent, mainly
due to differences in the provision levels.

If we observe the data from the year 2018 we see that the bank initially suffered a
significant amount of losses and the instance we reduce the provisions of NPA and add
that back to the net profit for the year, the banks' losses gets turned into profits. This
clearly shows the extent to which NPAs are affecting banks profitability and financial
soundness by means of comestibles for NPA.
Table 2: State Bank of India (Figures in Rs. Crores)
State Bank of India - Standalone
2012 2013 2014 2015 2016 2017 2018 2019
Net Profit for the year 11707.29 14104.98 10891.2 13101.6 9950.65 10484.1 -6547.45 862.23
- Provision for NPA
Provisions for NPA 11494.1 10656.97 14224 17487.4 29880.77 32905.6 71374.2 54617.72
Percentage Change in 20.48 -22.78 20.30 -24.05 5.36 -162.45 -113.17
Net Profit
Percentage Change in -7.28 33.47 22.94 70.87 10.12 116.91 -23.48
NPA Provisions
Net Profit for the year 23201.39 24761.95 25115.2 30589 39831.42 43389.7 64826.75 55479.95
+ Provision for NPA

Figure 3 represents the data which is described in Table 2, showing comparison among
Net profit for the year with and without NPA. We can clearly observe the impact of
provisions on net profit especially in the year 2018 where losses have been converted into
profits.
The Empirical Economics Letters, 19 (Special Issue) (October 2020) 135

Figure 3: Trends regarding net profits and provisions for NPA vis-à-vis SBI

80000
70000
RS (CRORES)

60000
50000
40000
30000
20000
10000
0
-10000
-20000
2012 2013 2014 2015 2016 2017 2018 2019
Net Profit for the year -
Provision for NPA 11707.2 14104.9 10891.1 13101.5 9950.65 10484.1 -6547.4 862.23

Net Profit for the year +

Provision for NPA 11494.1 10656.9 14224 17487.4 29880.7 32905.6 71374.2 54617.7

Figure 4: Percentage increase in Net Profit over the years considering NPA as non-
factor vis-à-vis SBI

7000.00 6334.47

6000.00

5000.00

4000.00

3000.00

2000.00

1000.00 300.29 313.86

98.18 75.55 130.60 133.48 -10.00
0.00
2012 2013 2014 2015 2016 2017 2018 2019
-1000.00

The trend line as per Figure 4 shows the percentage increase in the overall net-profit if we
add the provisions amount for NPA to the net profit of bank per yearly basis (2012-2019).
The Empirical Economics Letters, 19 (Special Issue) (October 2020) 136

This trend line shows the years in consideration. We can see that the profit would have
increased by 98.18 % in the year 2012, 75.55 % in 2013, 130.60 % in 2014, 133.48 % in
2015, 300.29 % in 2016, 313.86 % in 2017, -10.00% in 2018 and 6334.47 % in 2019. The
net profits would have increased for the banks by this massive percentage, which would
have been used for bank’s development and would have contributed towards the financial
soundness of bank.
5. Conclusion
A comparative scrutiny of HDFC Bank (leading private bank) and SBI (leading public
bank) reveals that the extent of provisions for NPA is much more in case of SBI (Table 2)
than that of HDFC Bank (Table 1) which indicates that the NPA would also be greater in
case of SBI as provisions are directly influenced by the quality and quantity of NPAs that
the bank is suffering through. The extent of impact of provisions for NPA on net profit is
more in case of SBI as its quantity is high which is acting as a roadblock in earning more
profits. The HDFC Bank is comparatively less affected and banks have also more
diversified sources of income than that of SBI. This comparison clearly indicates that
public sector banks are much worse in terms of NPAs when compared with that of private
sector banks. The extent of NPA in government banks is so high that if its provisioning is
removed from the net loss, the loss gets turned into profits.
From the findings, it can be deduced that the provisions for NPA do impacts the net profits
of the banks. Provisions for NPA significantly affect the profit earning potential of the
banks. Since provisioning is done based on the quality of NPA, we can conclude that the
magnitude of non-performing assets adversely influences the profits of the banks. It is
observed that the net profit of both HDFC Bank and SBI significantly increased when the
provisioning is removed and added back to the profits.
The problem of NPAs needs to be tackled, and measures should be taken to prevent the
rise of NPA in future. In 2019, the Ministry of Finance’s data revealed that the
government’s strategy of 4R’s, i.e., Recognition, Resolution, Recapitalization and
Reforms had reduced the extent of NPAs. The main emphasis was made on
recapitalization strategy. According to Mohapatra and Jha (2018), the Indian government
mainly recapitalizes the public sector banks in the hope that the situation will improve.
Still, it merely acts as a Band-Aid to the underlying sickness. The archaic governance and
accountability structures are required to be altered as per the current requirements. The
boards of the government banks need to be empowered to take timely corrective measures
so that the malaise of non-performing assets can be eradicated from the banking sector.
The Empirical Economics Letters, 19 (Special Issue) (October 2020) 137

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