1. Chartered Accountants
Prudential Norms on Income Recognition ,Asset Classification & Provisioning of Advances
AKOLA Br of WIRC of ICAI
18th March2017
CA Nitin S Bangad
Partner
S M Bangad & Co
Chartered Accountants
Aurangabad & Mumbai

2. Agenda
Discussion on Master Circular (MC) issued by RBI on IRAC Norms covering
Asset Classification
Provisioning
Income recognition
Project Loans
Case Studies
Restructuring of Advances

3. Introduction
The system of NPA classification was introduced by RBI for the banks w.e.f 31/03/1993.
Master Circular (MC) issued by RBI every year, however not in 2016 so the MC dtd 1st July, 2015 is relevant
One of the most important areas in bank audit, consuming major time of the auditors.
Identification & Classification of NPA is claimed to be system driven, however appropriate checks of the parameters needs to be made.
Inspite of use of technology & quarterly classification by the bank, no decrease in MOC’s by statutory auditors at the year end.
Primary responsibility of making proper NPA classifications & provisioning is of the bank management & statutory auditors.

4. Introduction Contd … Position of Gross NPA’s as per RBI Rs in Crores
(Source : RBI website database on Indian Economy)
Further Increase in NPA during the current year.
Particulars
31st March, 2015
31st March, 2016
SBI & Associates
73508
121969
Private Banks
33361
56185
Other Nationalized Banks
204960
417988
Total
311829
596142

5. Asset Classification… Basic Concepts
Standard Assets:- An asset which is not NPA & which does not carry more than the normal risks attached to the business.
Further bifurcation of Standard accounts is required in certain cases
Non Performing Assets :- An asset is treated to be non performing when it ceases to generate income for the bank.
Ceases to generate income if the interest charged in an account is not realized within the prescribed time without considering the security available
Categories of NPA
Substandard:- An NPA for the period of less than or equal to 12 months from the date of NPA
Doubtful :- An NPA for a period more than 12 months from the date of NPA. Even accounts with serious credit impairment / no security below 12 months.
Loss :- Account identified as uncollectible with negligible salvage or recovery value & not written off in the books.

6. Asset Classification… Basic Concepts
Out of Order :-
An account will be treated as “out of order” if the outstanding balance in the account is over the sanctioned limit / DP continuously for more than 90 days.
Even if the outstanding balance is below the sanction limit, but the credits in the account are not sufficient to cover the interest debited, or as on the Balance Sheet date there are no credits during the last 90 days, still the account is considered as “out of order”.
Over due :
Any amount due to the bank not paid on the due date is considered to be overdue.
Three aspects for checking of NPA
Fresh Identification
Proper Movement of classification from one category of NPA to another.
Upgradation of loan accounts earlier classified as NPA.

7. Guidelines on Asset Classification
Availability of security or net worth of the borrower / guarantor should not be considered while classifying the account.
Classification of account should be based on the record of the recovery & an account should not be classified as NPA merely for temporary deficiencies such as non receipt of stock statement, non renewal of limits, balance outstanding exceeding the limits/ DP, etc. However, the following would be treated as NPA
DP allowed on stock statement older than 3 months & such irregular drawings permitted for more than 90 days.
Limits not reviewed / renewed within 180 days from the due date.
Outstanding in the account continuously above the DP/limits
The asset classification should be borrower wise and not facility wise, except in certain cases such as loans to PACS, bills discounted under LC, etc.

8. Guidelines on Asset Classification ……Contd…
Borrower wise NPA classification does not extend to the group concerns & the classification status of each entity in the group needs to be identified separately.
Advances against TDR’s / KVP/IVP, LIC Policies should not be treated as NPA if sufficient margin is available. Advances against gold ornament / Govt. securities to be classified as per regular norms.
For advances where moratorium for payment of interest is given, the interest becomes due only after the end of the moratorium period & hence the account should not be treated as NPA if the interest is not serviced when debited to the account.
Where there is substantial erosion in the value of security (by more than 50%) account needs to be directly classified as doubtful. Where the value of security is less than 10% of the outstanding amount account to be classified as Loss.
In case of frauds entire amount due to the bank / amount for which the bank is liable (without considering the value of security) to be provided.

9. Fresh identification of NPA
Loans with Fixed repayment period ie Term Loans/ Demand loans/ Personal loans :- A loan is treated as a non-performing asset (NPA) if interest and/or instalment of principal remain overdue for a period of more than 90 days
As per Para of the MC, “In case of interest payments, banks should, classify an account as NPA only if the interest due and charged during any quarter is not serviced fully within 90 days from the end of the quarter”
E.g. :- If interest is charged in a TL A/c. on 31st Oct, 2016 & if the interest is not serviced within 90 days from 31st Dec, 2016 then only the TL A/c. would be treated as NPA not otherwise.
Cash Credit / Overdraft :- A cash credit or overdraft account is treated as NPA if it remains out of order for a period of 90 days or more.
Credit Card :- To be treated as NPA, if the minimum amount due as shown in the statement is not paid within 90 days from the due date as given in the statement.

10. Fresh identification ……Contd…
Bills purchased & Discounted :- Bills purchased and discounted are treated as NPA if they remain overdue and unpaid for a period of more than 90 days.
Securitisation:- The asset is to be treated as NPA if the amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of guidelines on securitisation dated February 1, 2006
Agricultural Advance :- A loan granted for short duration crops will be treated as NPA, if the installment of principal or interest thereon remains overdue for two crop seasons and, a loan granted for long duration crops will be treated as NPA, if the installment of principal or interest thereon remains overdue for one crop season
(Note :- Above norms applicable only to direct agricultural advances & for indirect agricultural advances regular norms would continue)

11. Fresh identification ……Contd…
Govt. Guaranteed Advances :- The credit facilities backed by Central Govt. guarantees to be treated as NPA only when the government repudiates its guarantee when invoked. In case of State Govt. guarantees no special treatment.
Advances under Consortium :- Classification of consortium advances should be based on the records of recovery of the individual bank & should not be guided by the classification of the other banks in the consortium.
Post shipment suppliers credit :-The portion of advances which is guaranteed by EXIM bank need not be treated as NPA.
Export Project Finance :- If the importer has paid the amount, but due to political reasons the bank abroad is not able to remit the funds, which is established by documentary evidences then account need not be classified as NPA up to a period of 1 year from the date of deposit by importers bank.

12. Fresh identification ……Contd…
Advances to PACS / FSS :- In case of advances granted under the on-lending system, only the particular credit facility granted to PACSs or FSSs, which is in default for a period of two crop seasons in case of short duration crops and one crop season in case of long duration crops, as the case may be, after it has become due will be classified as NPA and not all the credit facilities sanctioned.
The other direct loans & advances, if any, granted by the bank to the member borrower of a PACS/ FSS outside the on-lending arrangement will become NPA even if one of the credit facilities granted to the same borrower becomes NPA.
Advance under Rehabilitation of BIFR/ Term Lending Institutions, etc. :- Even after rehabilitation the existing asset classification to continue.
Upgradation of classification only after one year of satisfactory performance.
For additional facilities sanctioned under package, IRAC norms to be applicable after one year.

13. Demonetization- Effect on asset classification
Consequent to demonetization RBI has issued two circulars dtd 21/11/16 & 28/12/16, having effect on asset classification as on Mar-17.
The above circulars provide that an additional period of 60/90 days beyond the applicable time to be provided to the following borrowers for recognizing a account to be substandard.
Running working capital accounts (OD/CC)/crop loans, with any bank, the sanctioned limit whereof is Rs. 1 crore or less;
Term loans, whether business or personal, secured or otherwise, the original sanctioned amount whereof is Rs. 1 crore or less, on the books of any bank or any NBFC, including NBFC (Micro Finance Institution). This shall include housing loans and agriculture loans;
Loans sanctioned by banks to NBFC (MFI), NBFCs, Housing Finance Companies, and Primary Agriculture Credits and by State Cooperative Banks to District Central Co-operative Banks.
The above guidelines will also be applicable to loans extended by DCCBs.
The limits at (a) and (b) above are mutually exclusive limits applicable to respective categories of loans

14. Demonetization- Effect on asset classification
The above guidelines are subject to the following conditions
It would apply to dues payable between November 1, 2016 and December 31,
It is also clarified that the aforesaid guideline is a short-term deferment of classification as substandard due to delay in payment of dues arising during the period specified above and does not result in restructuring of the loans.
Dues payable before November 1 and after December 31, 2016, will be covered by the extant instruction for the respective RE with regard to recognition of NPAs.
The additional time given shall only apply to defer the classification of an existing standard asset as substandard and not for delaying the migration of an account across sub-categories of NPA.
The effect of the above would be that the eligible borrowers would get additional time for payment of dues of Nov & Dec16 by 60/90 days.

15. Fresh Identification of NPA’s – How ?
Check if all accounts of the borrower are tagged under a single customer ID
Position of the branch as of the last quarter / month as available.
Loan balance file / CC/OD balance file if available in soft form can be taken and analysed.
List of SMA accounts reported to higher authorities.
For crop loans to confirm if the area of the branch is covered under any natural calamity.
Care / caution to be taken for ever greening in the accounts such as.
Cash deposit shown without actual cash receipt (Agri. Loans)
Cheque purchase shown at the year end but returned in the next year.
Transfer from sister concerns accounts.
Recoveries from new limits sanctioned.

16. Movement of existing NPA’s to other categories
Copy of last years audited classification & MOC to be taken.
Check if old NPA’s properly classified based on the NPA date.
Valuation of securities as per prescribed norms of 3 years.
Shifting of NPA accounts from one category to another, based on severe credit impairment or heavy erosion in the value of security.

17. Upgradation of NPA’s
Upgradation of current years NPA & previous years NPA to be thoroughly checked.
Upgradation of loans (other than re-structured) to be done only after recovery of full arrears of principal & interest due & not the critical amount due. The status of the account should be “No overdue” instead of “Overdue within 90 days”.
Upgradation within the NPA category is not permitted i.e. a Doubtful account cannot be made Sub-standard even if the overdue are reduced to less than 12 months.
Agri. Advances affected by natural calamities.
Banks to decide on their own regarding measures to be taken for conversion of short term loans or re-schedulement of repayment period & sanctioning of fresh short term loans subject to guidelines of RBI.
In cases of conversion or re-schedulement, the term loan as well as fresh short-term loan may be treated as current dues and need not be classified as NPA.

18. Provisioning Norms Standard Asset Farm Agricultural and SMEs
Commercial Real Estate (CRE)
(CRE) Residential Housing
All Others not included above
Housing Loans (Teaser)
0.25 %
1.00 %
0.75 %
0.40 %
2.00%
Sub Standard Asset
Outstanding (secured)
Outstanding (Unsecured )
15.00 %
25.00%
Bad & Doubtful Asset
Doubtful I – upto 1 year (Secured Portion)
Doubtful II – 1 to 3 years (Secured Portion)
Doubtful III – more than 3 years
Unsecured Portion of all I, II
25.00 %
40.00 % %
100.00%
Loss Asset
Total Outstanding

19. Income Recognition
The policy followed by the bank on IRAC should be objective & based on record of recovery & not subjective.
Income on NPA accounts to be recognized only when actually received & not on accrual basis (even for Govt. guaranteed A/c’s). However, the recovery should not be from fresh / additional facilities sanctioned.
Interest on advances against TDR, KVP / IVP, LIC policy, etc. to be recognized on accrual basis if adequate margin is available.
Fees & commissions earned by the bank on re-scheduled loans should be treated as income on accrual basis over the period of the loan.
In case of NPA A/c., if the income credited on accrual basis in the past is not realized then such income needs to be reversed.
Bank should follow an accounting policy, for appropriation of recoveries in NPA A/c., which is uniform & consistent if there is no clear agreement between the bank & borrower regarding the appropriation of recoveries.

20. Early recognition of Financial Distress
As per RBI guidelines effective from April 1, 2014 banks have to further classify the “Standard” accounts into four categories, with a view of early detection of financial distress.
Central Repository of Information on Large Credits (CRILC) is formed by RBI & banks to report the status of all accounts where the aggregate FB& NFB limits are more than Rs 5 Cr.
SMA Subcategories
Basis for classification
SMA – 0
Principal or interest payment not overdue for more than 30 days but account showing signs of incipient stress (Please see Appendix to Part C)
SMA – 1
Principal or interest payment overdue between days
SMA – 2
Principal or interest payment overdue between days

21. Early recognition of Financial Distress
Following are the signs of stress if observed in any account then to be categorised as SMA-0.
Delay of more than 90 days in submission of stock statements/ other financial data.
Sales/operating profit lesser than projections by more than 40%.
Preventing banks from conducting Stock audit/reduction in DP by more than 20%after stock audit.
Evidence of diversion of funds/ Drop in risk rating by 2 or more notches.
Return of 3 or more cheques for want of funds in 30 days.
DPG/LC/BG devolved & not adjusted within 30 days.
Third request for extension of time for creation / perfection of charge of the bank on securities.
Increase in frequency of OD in Current A/cs
The borrower reporting stress in the business/ financials.
Promoters selling / pledging their shares in the borrower company due to financial stress.

22. Early recognition of Financial Distress
If banks do not report the SMA status of an account as required then the banks have to make following accelerated provisioning.
(Note: NI=Non Infrastructure , I=Infrastructure , S= Secured , U=Unsecured)
Asset
Classification
Period as NPA
Current provisioning
(%)
Revised Accelerated provisioning (%)
Sub – Standard Secured
Up to 6 Months
6 M to 1 Year 15 25
Sub – Standard Unsecured
25 (NI) /20 (I)
25 (NI)/20 (I) 40
Doubtful I
2nd Year
25 (S)/100 (U)
40 (S)/100 (U)
Doubtful II
3rd & 4th Year
100 (S & U)
Doubtful III
5th Year onwards

23. PROJECT LOANS

24. Project Loans
Project Loan: A Term Loan extended for the purpose of setting up of an economic venture.
Project Loans of Two Types:- Infrastructure / Non Infrastructure
Banks should fix date of completion (DOC) and Date of Commencement of Commercial Operations (DCCO) for all project loans at the time of sanction of the loan / financial closure
For these loans banks are allowed to continue the status of loans as “Standard” in the following cases subject to certain conditions
Deferment of DCCO
Change in ownership
Increase in project outlay due to increase in scope & size of the project
The above cases would not be considered as restructuring, though the repayment period & other loan conditions will change.

25. Guidelines on Asset Classification- Project Loans
Deferment of DCCO
Deferment of DCCO & consequential change in repayment terms will not be considered as re-structuring subject to following conditions.
For infrastructure projects the revised DCCO falls within a period of 2 years. For non infrastructure project the period is 1 years.
No change in other terms & conditions.
If revision in DCCO is beyond the time limits given above then following condition to be complied.
For infrastructure projects involving court cases further period of 2 years is allowed (2 + 2 = Total 4 years)
For infrastructure projects delayed for reasons beyond the control of the promoters additional period of 1 years is allowed (2 + 1 = Total 3 years)
For non-infrastructure projects delayed for reasons beyond the control of the promoters additional period of 1 years is allowed (1 + 1 = Total 2 years)
The above classification benefits are not available to project under commercial real estate.

26. Deferment of DCCO ……. Contd..
To avail the benefit of standard classification, following conditions needs to be complied.
The application for re-structuring should be received before expiry of the above period till the time the account has standard classification.
In cases where moratorium for payment of interest is given, banks should not book interest income on accrual basis beyond the initial period.
Provision on the standard assets to be higher than the others.
Multiple revision of DCCO within the above stipulated period would be considered as single event of re-structuring, provided the total deferment of DCCO does not exceed the limits above & the other terms & conditions are same.
Banks may fixed the DCCO outside the limits given above, but the “standard” status of the account will not continue.

27. Guidelines on Asset Classification- Project Loans
B) Change in ownership
To facilitate revival of the projects stalled due to in adequacies of the current promoters & change in ownership takes place by the time upto original DCCO or the extended time, a further period of two years for deferment of the DCCO is allowed.
The following conditions needs to be complied.
Banks to established that the project is stalled due to current promoters & there is a high probability of CCO if there is change in ownership.
The new promoter should have sufficient experience in the project / activity involved.
The new promoters should hold at least 51% of the paid up capital of the new project.
Viability of the project should be established to the satisfaction of the banks.

28. Change in Ownership…….Contd…
The banks should clearly establish that the acquirer does not belong to the existing promoter group
Asset classification of the account as on the ‘reference date’ would continue during the extended period.
Reference date means the date of execution of preliminary binding agreement between the parties to the transaction, provided that the acquisition/takeover of ownership as per the provisions of law/regulations governing such acquisition/takeover is completed within a period of 90 days from the date of execution of preliminary binding agreement.
The new promoters should bring substantial money to show their commitment to complete the project in time & funding the costs overruns.
While extending the DCCO banks to take care that the repayment of the loan is covered within 85% of the economic life of the project.
This facility is available only once & not for subsequent change in ownership.

29. Guidelines on Asset Classification- Project Loans
C) Increase in project outlay due to increase in scope & size of the project
The following conditions needs to be complied.
The increase in scope and size of the project takes place before commencement of commercial operations of the existing project
The rise in cost excluding any cost-overrun in respect of the original project is 25% or more of the original outlay
The bank re-assesses the viability of the project before approving the enhancement of scope and fixing a fresh DCCO.
On re-rating, (if already rated) the new rating is not below the previous rating by more than one notch

30. Project Loans….Contd.
Classify as NPA during any time before commencement of commercial operations as per record of recovery (90 days overdue), unless restructured and eligible to be classified as standard. ( & )
Income Recognition
On accrual basis for standard accounts & cash basis for NPA
In case of FITL a provision for an equal amount treated as income needs to be made in an account “Sundry Liabilities A/c (Interest capitalization)”

31. Project Loan- Other Issues
Mere extension of DCCO within permitted time limits & consequential shift in repayment period by equal or shorter duration would not mean restructure, provided all other terms & conditions remain unchanged.
CRE projects merely extension of DCCO would not be considered as restructuring, if the revised DCCO falls within a period of 1 year from original DCCO & there is no change in other terms & conditions except possible shift of repayment schedule and servicing of loan. Such CRE projects will be treated as Standard.

32. Case Study

33. Case Study
A term loan is granted & EMIs are payable at the start of every month on 1st day of the month. What will be the date of becoming NPA (sub- standard) in the following cases.
Term loan amount Rs 90 lacs & EMI due on 1st Oct,2016 is not received till
Term loan amount Rs 90 lacs & EMI due on 1st Nov,2016 is not received till
Term loan amount Rs 110 lacs & EMI due on 1st Nov,2016 is not received till

34. Amount received towards EMI’s (Rs)
Case Study
Housing loan of Rs lacs was disbursed on 1/5/2012 for ready possession flat & repayment was to commence after moratorium of 6 months i.e. 1st Nov, 2012 & repayable by way of 180 EMIs (principal + Int) of Rs per month.
Following is the position of yearly EMIs due & EMIs received as on
Whether the account should be classified as NPA as on ?
Financial Year
Amount received towards EMI’s (Rs)
225000
540000
505000
525000
Total

35. Case Study A borrower has been sanctioned following limits :-
Term Loan Rs 1000 lacs
Working capital (CC) Rs 500 Lacs
Bill discounting under LC Rs 200 lacs
What will be the classification of all the above a/cs in the following cases (assuming other accounts are being operated as per guidelines) :-
Term loan has been classified as sub-standard due to non-payment of dues as on
Bill discounting under LC has been classified as NPA as on

36. Case Study
CC limitof Rs 200 lacs was sanctioned & disbursed on 10/4/16. What will be the classification as on in each of the following cases where stock statements are not received regularly?
Last stock statement on record is of Aug-16
Last stock statement on record is of Nov-16

37. Case Study
Car loan of Rs 20 lacs was sanctioned & disbursed on However during the current year, the hypothecated car met with an accident & salvage value is estimated to be around 5 % of loan outstanding. Further, insurance claim is expected to be rejected as insurance premium was not paid & policy stood expired on date of accident. Further as on , 5 EMIs were due.
What will be the classification of such account.

38. Restructuring of Advances

39. Restructuring of Advances
Four Broad Catagories:
Advances extended to Industrial Units(IU)
Advances extended to IU under CDR
Advances to SME
All other advances
Exception: Advances restructured due to natural calamities relating to Agriculture
Eligibility
Any account classified under standard, sub standard and doubtful categories.

40. Restructuring of Advances………. Contd..
Restructuring cannot be done retrospectively.
While the restructuring proposal is under consideration, usual asset classification norms would continue to apply.
Asset Classification status on date of approval of restructuring relevant to decide the asset classification status after such restructuring
Restructuring should be subject to customer Application / consent for terms and conditions.
Financial viability should be established and there is reasonable certainty of repayment.
Borrowers indulging in frauds & malfeasance are ineligible.
BIFR cases are not eligible without their express approval.

41. Restructuring of Advances………. Contd..
Standard Asset would get reclassified as sub standard immediately
Account which is already NPA would continue to have the same classification & may slip further based on pre-restructuring repayment schedule.
Additional finance would be treated as standard up to a period of one year. After that the classification of other accounts of the borrower will apply.
All restructured accounts, classified as NPA upon restructuring would be eligible for upgradation after observation of satisfactory performance during the specified period. (during 1year it should not be out of order for more than 90 days and no overdue at the end)

42. Restructuring of Advances- Provisioning Norms
Provision on restructured advance as per extant provisioning norms.
Standard restructured advances will attract higher provision for first 2 years. In case of moratorium, this period will also be covered for treating as standard.
NPA restructured advances when upgraded to standard attract higher provision in first year.
Diminution in fair value is an economic loss to bank & needs additional provision on each BS date.
For advances below Rs.1 crore, 5% of total exposure can be provided notionally for such diminution in fair value of advance.
Provision for diminution in fair value is in addition to the normal provisions required.
Both the above provision will not exceed 100% of the outstanding amount.

43. Restructuring of Advances- Provisioning Norms
Special Regulatory Treatment for asset classification.
Not available to Consumer & Personal Advances, Advances classified as Capital Market Exposure, Advances classified as Commercial Real Estate Exposure.
The special regulatory treatment for asset classification is available subject to compliance of the following conditions.
Dues of the bank are fully secured by tangible security (except SSI borrower with outstanding upto Rs.25 lacs & infrastructure projects)
Unit becomes viable in 8 years, if it is engaged in infrastructure activities and in 5 years in case of other units.
Repayment period including moratorium does not exceed 15 years for infrastructure & 10 years for other projects (10 years ceiling won’t apply to restructured Home Loans).
Promoters' sacrifice and additional funds brought by them should be a minimum of 20 per cent of banks’ sacrifice or 2 per cent of the restructured debt, whichever is higher
The restructuring under consideration is not a 'repeated restructuring‘.

44. Restructuring of Advances- Provisioning Norms
W.e.f. April 1, 2015, a standard account on restructuring (for reasons other than change in DCCO) would be immediately classified as sub-standard on restructuring as also the non-performing assets, upon restructuring, would continue to have the same asset classification as prior to restructuring and slip into further lower asset classification categories as per the extant asset classification norms with reference to the pre-restructuring repayment schedule.

45. Income Recognition on Restructured Advances
For restructured accounts classified as “standard” income to be booked on accrual basis.
For restructured accounts classified as NPA income to be booked on cash basis.
If other facilities are treated as NPA, the income on the additional finance should be recognised only on “cash basis” though it may be classified as “standard” for one year.
The unrealised income represented by FITL / Debt or equity instrument should have a provision in an account styled as "Sundry Liabilities Account (Interest Capitalization)".
Only on repayment in FITL, P&L A/c. to be credited & Sundry Liabilities A/c. to be reduced.

46. Questions ? ? ?

47. Feed back Visit
Contact : /