This is how I think about this:
Banks are highly leveraged, with an average Asset/Equity ratio of 10/1 that is Debt to Equity ratio of 9/1. A 10% loss on the assets (which are primarily Loans) will make the equity ZERO. Regulatory guidelines mandate the bank to maintain certain threshold of equity w.r.t debt to remain solvent and ready to extend new credit in the economy.
NPAs: Typically these are of two types- Gross NPAs and Net NPAs.
Gross NPAs reflect the amount of LOANS/ADVANCES on which payment is due from past 90 days. Interest income from such accounts is not accumulated in P&L after labeling them as NPAs to avoid reporting of ghost profits, which results in ballooning of equity. The principal amount blocked in such loans belongs to depositors and banks are accountable to repay the same.
Provisioning is the mechanism to back-fill the depositors money from bank’s earnings. Provision is an expense that is deducted from quarterly profits to reduce the Gross NPAs.
Net NPAs (= Gross NPAs- Provisions) is the effective principal amount blocked as NPAs and banks are hopeful to recover the same in subsequent period. If not recovered, P&L will take a charge in the form of Provisions.
Credit Cost: The EXPECTED loss, which varies as per product category, on the LOANS/ADVANCES extended by the bank. Assume a bank that loans money only for one product category- Home Finance, which has a Credit Cost of 1% as per historical norm/ industry standard. The bank has taken deposit of Rs.100 from customers/financial institutions at 5% and plans to earn 4% spread. In order to earn a spread of 4%, the loan to home buyers WILL be extended at 10%.
In nutshell, Credit costs are the losses which were EXPECTED as per managements judgement. Due to poor economy or lenient underwriting, NPAs are the losses that are REALIZED, if no recovery happens. Provisioning is the mechanism to apply realized losses to banks profit/equity in a graceful manner so that the bank’s equity does not reflect irrational exuberance.