The effectiveness and stability of the banking industry are key factors in the expansion of the economy.The foundation of any bank is built on trust and faith. However, the rising NPAs of banks have a negative impact on this trust and confidence.NPAs are basically the financial burden to banks.The magnitude of NPAs is the most crucial variable used to gauge the health of the banking sector. The financial performance of banks is directly impacted by non-performing assets, i.e.their profitability. NPA (Non-Performing Asset) is a critical factor which has adversely impacted the development and growth of the economy of the country.Non-Performing Assets, or NPAs, are like a cancer worm that have been slowly but surely devouring India's banking sector.NPAs are bad loans with banks or other financial institutions whose interests and or principal amounts are overdue for a long time. Banks run its business like any other business with a view to earn profits but NPAs eat their margin. A strong banking system is seen as the foundation of an emerging economy. RBI along with Government of India has come with numerous policies to strengthen the sector in order to achieve favorable growth, assets quality and profitability. Non-Performing Asset is the best indicator of a nation’s Banking System. It reflects the performance of banks. Reductions in NPA often signify that the credit evaluation process has been tightened, while increases in NPAs point to the need for balance sheet maintenance and will have an impact on the profitability of banks. The NPA must be decreased and controlled in order to increase the effectiveness and profitability of banks. A number of warning signs indicating assets are slipping into becoming NPAs have been highlighted by RBI. The following parameters were chosen for Reasons of NPAs: 1. Market Failure 2. Willful Defaults 3. Poor follow-up and Supervision 4. Non-cooperation from Banks 5. Poor Legal framework 6. Lack of Entrepreneurial Skills 7. Diversion of funds A.Non-Performing Assets (NPAs) Reserve Bank of India has provided guidelines for determining when an asset becomes NPA. 1. If interest or a principle installment for a term credit is past due for more than 90 days, it is regarded as non-performing.According to RBI’s latest announcement, the bad loan classification period now changed from 90 days to 180 days for all such accounts. 2. Overdraft/Cash Credit (OD/CC) amounts that consistently exceed the authorised limit for more than 90 days are regarded as non-performing assets (NPA). 3. If the overdue bills purchased and discounted exceed ninety days then it is a non-performing asset. 4. If interest or a principal installment for agricultural advances is payable across two harvest seasons but not more than two terms of six months due to advance granted, then it is considered as NPA. 5. Any receivable that is past due on another account for more than 90 days is regarded as a non-performing asset (NPA). B. Classification of NPA 1. Standard Assets: It does not create any problem while paying interest/ installments of the principal. It typically comes with higher-than-average business risk. 2. Substandard Assets: An asset is classified as a sub-standard asset if it remains as an NPA for a period less than or equal to 12 months. 3. Doubtful Assets: An asset is classified as a doubtful asset if it remained as an NPA for more than 12 months. 4. Loss Assets: An asset is considered as loss asset when it is uncollectible and it has not been written off wholly or in parts. C. Impact of NPA 1. Profitability: The profits and NPAs are inversely proportional. With increase in NPA, there will bedecrease in profits because the banks do not receive the payments and along with this the banks also need to create bigger provisions according to the type of NPA. 2. Credit contraction: With increase in the NPAs, funds are not easily reused causing a decrease in the lending capacity of banks thereby decreasing the income of the banks. A monetary log jam may be caused if the NPAs contract the cash stock. 3. Liability Management: With rise in NPAs, the interest rates of deposits will be reduced by the banks and interest rates on loans will be increased in order to maintain net interest margin. This may cause hindrance in the overall functioning of financial sector as customers will not easily get loans and even if they get it, they may have to pay high interest and this will hampers the banks business and also economic growth. 4. Shareholders’ confidence: Usually shareholders are mainly concerned about gaining higher dividends on their investments. However if the banks have high NPAs then the profits earned by the banks are very less which in turn means that the shareholders might get very low dividends and in some cases they might not get their money back. The banks are required to obtain an approval from the RBI before declaring the dividend if the banks have net NPA level at 5% or more. 5. Public certainty: With rise in NPA, the population starts questioning the credibility of the banks and may show resistance which in turn will cause liquidity issue in banks as people may not invest or deposit money in the banks. As a result, increasing NPAs are neither healthy for the economy nor the banks' earnings. Early Warning Signals: As recommended by RBI, a non-performing asset can be detected using a few early warning signs.These early warning signs can be divided into five groups in general: (a) Financial (b) Operational (c) Banking (d) Management (e) External factors. (a) Financial warning signals: • Persistent irregularity in the account • Default in repayment obligation • Devolvement of LC/invocation of guarantees • Deterioration in liquidity/working capital position • Substantial increase in long term debts in relation to equity • Declining sales • Operating losses/net losses Rising sales and falling profits • Disproportionate increase in overheads relative to s • Rising level of bad debt losses (b) Operational warning signals: • Low activity level in plant Disorderly diversification/frequent changes in plan • Nonpayment of wages/power bills • Loss of critical customer/s • Frequent labor problems • Evidence of aged inventory/large level of inventory (c) Management warning signals: • Lack of co-operation from key personnel • Change in management, ownership, or key personnel • Desire to take undue risks • Family disputes • Poor financial controls • Fudging of financial statements • Diversion of funds (d) Banking related signals: • Declining bank balances/declining operations in the account • Opening of account with other bank • Return of outward bills/dishonored cheques • Sales transactions not routed through the account • Frequent requests for loan • Frequent delays in submitting stock statements, financial data, etc. (e) Signals relating to external factors: • Economic recession • Emergence of new competition • Emergence of new technology • Changes in government / regulatory policies • Natural calamities: These signals help the banks to identify those weak assets which may become NPA