The problem of NPAs in Indian banking system is one of the most important and formidable problems which has impacted the entire banking system. A higher NPA ratio shakes the confidence of investors, depositors, financiers, etc. It also causes poor recycling of funds, which in turn will have deleterious effects on the provision of credit. Failure to recover loans affects not only the further availability of credit, but also the financial soundness of banks. Say no to plagiarism. Get a tailor-made essay on "Why Violent Video Games Shouldn't Be Banned"? Get Original Essay Profitability: NPAs have a negative impact on profitability as banks stop earning on one hand and attract higher provisions than standard assets on the other hand. On average, banks provide around 25-30% additional provisions on incremental investments, which has a direct impact on banks' profitability. Asset Contraction (Credit): Increase in NPAs puts pressure on money laundering and reduces the ability of banks to lend more and therefore results in lower interest income. It contracts the money supply, which can lead to an economic slowdown. Liability Management: In light of high NPAs, banks tend on one hand to lower interest rates on deposits and probably impose higher interest rates on advances to support NIM. This could become an obstacle to the smooth process of financial intermediation and hinder the activity of banks and economic growth. Capital adequacy: Under Basel rules, banks are required to maintain adequate capital on risk-weighted assets on an ongoing basis. Every increase in the NPA level adds to the risk-weighted assets that ensure banks further strengthen their capital base. Capital is priced between 12% and 18% as it is a scarce resource. Shareholder Confidence: Normally, shareholders are interested in increasing the value of their investments through higher dividends and market capitalization, which is only possible when the bank records significant profits through improved business. Increasing level of NPAs is likely to have a negative impact on banking business and profitability, therefore shareholders do not receive a market return on their capital and sometimes this may erode the value of investments. As per the existing guidelines, banks whose net NPA level is 5% or more are required to obtain prior permission from the RBI to declare dividends and also set a limit on dividend payments. Please note: this is just an example. Get a custom paper from our expert writers now. Get a Custom Essay Public Confidence: The credibility of the banking system is also severely affected due to higher level NPAs because they undermine the general public's confidence in the soundness of the banking system. Rising NPAs could pose liquidity problems which could lead to bank runs by depositors. Therefore, the higher incidence of NPAs not only affects the performance of banks but also affects the economy as a whole. Simply put, high incidence of NPA has a cascading impact on all important financial ratios of banks i.e. net interest margin, return on assets, profitability, dividend payout, ratio reserve coverage, credit contraction etc., which is likely to erode. The.