A friend recently asked me if a particular bank stock is worth investing in. He looked at the income and profit numbers and felt confident. But I asked just one question: “Do you know how well the bank collects its loans?” That got him thinking. I told him that just looking at profits, income, or share price isn’t enough.
To understand how well a bank or NBFC is doing, you need to look at some behind-the-scenes numbers like loan growth, ROE (Return on Equity), GNPA, NPA, Credit cost, and Capital adequacy (CAR). These tell one not just how much money the company is making, but also how safely it’s growing, and whether it can continue to grow without running out of money or taking too much risk.
This blog is for anyone like my friend who is curious about banks and investing but does not have a finance background. Let’s break it down together and explore that with a simple example.
What is an NPA?
A bank gives loans. But sometimes, people or companies don’t repay on time. When a borrower doesn’t pay for 90 days or more, the loan becomes an NPA — Non-Performing Asset. This simply means it’s not earning anything for the bank anymore.
Think of it like this: You lend a friend ₹1000, and they don’t return it for 3 months. You start worrying — that’s exactly what a bank does with NPAs.
What is SMA, DPD and Loan Staging?
Banks keep track of how many days late a loan is. This is called DPD (Days Past Due) and that helps to classify loan accounts as SMA (Special Mention Account). Based on this, loans are grouped into different stages:
| DPD (Delay) | SMA Category | Stage | Meaning |
| 0 days | Standard | Stage – 1 | Performing loan, payments on time |
| 1-30 days | SMA – 0 | Stage – 1 | Slight delay, but still considered performing |
| 31-60 days | SMA – 1 | Stage – 2 | Moderate delay; borrower may be stressed |
| 61-90 days | SMA – 2 | Stage – 2 | High alert; likely to turn into an NPA |
| 91+ days | NPA | Stage – 3 | NPA (Bad loan) |
When a loan reaches Stage 3, it is considered a bad loan.
What Are Provisions?
Banks don’t just hope for the best. They keep some money aside to prepare for losses. This is called a provision. The higher the risk, the more money they keep:
- Stage 1: Small provision (~0.4%)
- Stage 2: Medium (~10–15%)
- Stage 3: High (~100% sometimes)
It’s like keeping an emergency fund if your friend doesn’t return the money.
What Do GNPA, NNPA, and Credit Cost Mean?
Let’s simplify these common terms:
| Term | What It Means |
| GNPA (Gross NPA) | Total value of all bad loans (stage 3 loans) |
| GNPA % | (GNPA / Total Loans) x 100 |
| Provision | Money kept aside by the bank to cover possible losses |
| NNPA (Net NPA) | GNPA – Provisions (still risky part not covered by provisions) |
| NNPA % | (NNPA / Total Loans) x 100 |
| Credit Cost | Provisions made in a year ÷ Total Loans (impact on bank profits) |
The Setup: A Bank with Ambition
Let’s say a bank has:
- Loan Book: ₹1,000 crore
- Wants to grow loans 20% per year
- Return on Equity (ROE): 15%
- Capital Adequacy (CAR): Minimum 13%, but comfort level is 18%
- It retains all profits (no dividend payout)
We’ll see how far this bank can go in 5 years without raising extra money — first under ideal conditions, then under stress due to bad loans and credit cost.
Scenario 1: Clean Case (No Bad Loans)
| Year | Loan Book (₹ Cr) | Required Equity @18% | Equity BOY | Profit @15% ROE | Equity EOY | Equity Gap | CAR EOY |
|---|---|---|---|---|---|---|---|
| 0 | 1,000 | 180.00 | 180.00 | – | 180.00 | – | 18% |
| 1 | 1,200 | 216.00 | 180.00 | 27.00 | 207.00 | 9.00 | 17.25% |
| 2 | 1,440 | 259.20 | 207.00 | 31.05 | 238.05 | 21.15 | 16.5% |
| 3 | 1,728 | 311.04 | 238.05 | 35.71 | 273.76 | 37.28 | 15.84% |
| 4 | 2,073.60 | 373.25 | 273.76 | 41.06 | 314.82 | 58.43 | 15.18% |
| 5 | 2,488.32 | 447.90 | 314.82 | 47.22 | 362.04 | 85.86 | 14.54% |
*BOY: Beginning of the year, EOY: End of the year
Summary:
- Profit adds to equity every year.
- But to keep growing loans 20% yearly with a safe 18% CAR, the bank will fall short by ₹86 crore by Year 5 unless it raises money. Without raising equity, CAR would be 14.54%.
Scenario 2: Stressed Case (Bad Loans & Credit Cost)
Now let’s assume:
- GNPA: 2%
- NNPA: 1% (assuming 50% provisioning)
- Credit Cost: 1% of the loan book every year (for provisioning)
- This reduces the available profit each year
| Year | Loans (₹ Cr) | Required Equity @18% | Equity BoY | Profit @15% ROE | Credit Cost (1%) | Net Profit | Equity EoY | Equity Gap | CAR EOY |
|---|---|---|---|---|---|---|---|---|---|
| 0 | 1,000 | 180.00 | 180.00 | – | – | – | 180.00 | – | 18% |
| 1 | 1,200 | 216.00 | 180.00 | 27.00 | 12.00 | 15.00 | 195.00 | 21.00 | 16.25% |
| 2 | 1,440 | 259.20 | 195.00 | 29.25 | 14.40 | 14.85 | 209.85 | 49.35 | 14.57% |
| 3 | 1,728 | 311.04 | 209.85 | 31.48 | 17.28 | 14.20 | 224.05 | 86.99 | 12.96% |
| 4 | 2,073.6 | 373.25 | 224.05 | 33.61 | 20.74 | 12.87 | 236.92 | 136.33 | 11.42% |
| 5 | 2,488.32 | 447.90 | 236.92 | 35.54 | 24.88 | 10.66 | 247.58 | 200.32 | 9.9% |
*BOY: Beginning of the year, EOY: End of the year
Summary:
- Credit cost eats into profits.
- The GNPA is at 2%, and the credit cost is 1%, slowing equity growth because provisioning eats into profits.
- Even with decent profits (15% ROE), the bank cannot internally fund its 20% growth while maintaining an 18% CAR.
- After 5 years, the bank is short by ₹200 Cr in equity to sustain its loan growth safely.
What This Teaches Us
Even if a bank shows good profits, bad loans and provisioning costs (credit cost) can silently eat into capital. If capital isn’t growing fast enough, the bank will eventually hit a ceiling and must raise new funds — either by issuing shares or debt.
Just like my friend learned, before investing in any bank, go a little deeper. Check not just how much profit it makes but also how well it collects its loans. Because when too many loans go bad, it’s not just a number — it’s your investment at risk. There is a famous saying:
Top line is vanity, bottom line is sanity, and cash flow is reality, the ultimate measure of an Bank / NBFC will always be scale, profitability and governance.