1. VERIFICATION OF ADVANCES - IRAC norms & practical issues Radhesh L. Bhat FCA 1

2. TOPICS COVERED  Verification of advances – vis. a vis RBI guidelines  Asset Classification/provision norms  Practical issues 2

3. 90 days norms TL - Interest/ Principal O/s for > 90 days OD/CC - “Out of Order” Balance exceeding DP/Limit No credits/ insufficient credits BP – Bills remains overdue for more than 90 days Long Duration- overdue for 1 crop season Short Duration- overdue for 2 crop season 3

4. Other NPA norms (4.2.4 of MC) Accounts with temporary deficiencies - if not renewed/reviewed within 180 days from due date - NPA - Adhoc limit if not renewed/reviewed within 180 days from due date -NPA [Applicable for good accounts also] Central Govt. Guaranteed Advances only for NPA classification, not for income recognition No exemption for State Govt. guaranteed 4

5. 90 days norms- Practical Considerations Stock statement - not to be older than 3 months. If yes irregular. Hence maximum 6 months Verify contents of stock statement Concept of paid stock Non moving stock/debtors > 6 months Physical verification – significance 5

6. 90 days norms- Practical Considerations Comparison with PY end stock statement vis a vis financials – wide variation? Stock audit Bank’s policy of computation 6

7. 90 days norms - Practical Considerations Interest due & charged in a qtr– 90 days from end of quarter (2.1.3 of MC) Concept of Overdue – Interest debited - – whether internal guidelines of 1 week/1 month applicable??? Beware of reversal entries – mistaken as credits To see day end balance (Intra day credits) 7

8. Beware of solitary credits near the Balance Sheet Date Credits from other accounts/other branches to regularise the account-check genuineness Continuously in excess, except for a few days at the end - mention In report Technically NPA at the year end – apply professional judgement – see the health of the account Availability of security/ networth – not a criteria for not treating as NPA 8 90 days norms- Practical Considerations

9. Check SMA list of February 2016 RBI/ Internal Inspection/ RBIA commented accounts Check position with other banks in case of Joint lending/Consortium 9

10. 90 days norms- Practical Considerations Bills purchased/ discounted over due from due date extension of due date vis a vis restructuring Beware of year end regularisation by chq purchase- Cheque Purchased on 31.3, not cleared on date. Packing credits – extension permitted within 90 days norms upto 360 days - To obtain letter from foreign buyer seeking extension of delivery of goods 10

11. Early detection - SMA : Not overdue for > 30 days  Banks to report to Central Repository of information on large credits of RBI (CRILC) Rs.50 million and above  If Aggregate exposure >Rs.1000 mn - JLF to be formed – JLF to decide Corrective Action Plan  Refer Appendix to Part C-1 of MC 2015 for illustrative list of signs of stress 11 SMA CategoryBasis of Classification SMA -0Principal/interest not overdue or >30 days, but shows sings of incipient stress SMA -1Principal/interest not overdue between 30 – 60 days SMA -2Principal/interest not overdue between 60 – 90 days

12. Failure in Early detection Accelerated provisioning norms to apply (apart from other supervisory actions) if: - banks fails to report SMA status of the accounts to CRILC or - resort to methods with the intent to conceal the actual status of the accounts or - evergreen the account Refer para 31 of MC – July 2015 for accelerated rates 12

13. Master Circular – Rupee/Foreign Currency Export Credit and Customer Service to Exporters dt July 1, 2015 Pre Shipment/ Packing credit- Granted to exporter for purchase/processing/manufacture/ packing/ WC expenses for services On the basis of L/C or confirmed Order If pre shipment is not adjusted within 360 days, cease to qualify for prescribed ROI. Liquidation – Out of bills drawn/ EEFC 13

14. Master Circular – Rupee/Foreign Currency Export Credit and Customer Service to Exporters dt July 1, 2015 Pre Shipment/ Packing credit- Operational Flexibility - Single A/c or Running A/c Facility - Mark off export bills on FIFO basis- 360 days - Liquidate though Export documents of any other order (Account in same bank/permission of consortium)- - Risk that exporter may avail of export from one bank and submit documents to another 14

15. Master Circular – Rupee/Foreign Currency Export Credit and Customer Service to Exporters dt July 1, 2015 Export Credit in foreign Currency PCFC is for a maximum of 360 days. If exceeds 360 days, PCFC is adjusted against TT Selling rate (crystallisation) 15

16. Verification of advances - Industries with stress: - Real estate, Retail, Automobiles, Etc…… Large Unfunded exposures – esp LC - frequent devolvement of LC–serious threat Test check RBI guidelines for acceptance of LC/BG followed  Reporting of excess sanction to higher authorities 16

17. Asset classification Borrower wise – not facility wise Exceptions: - Advance against NSC/FD - Bills discounted under LC of other banks- not to be treated as NPA even if other facilities are NPA, unless the other bank refuses to accept the documents under LC 17

18. Asset classification Upgraded during the year– Restructured / others – - ensure strict compliance of norms. Bank’s classification may not be adequate. Temporary deficiencies – case to case depending upon health. 18

19. Asset classification Advances under consortium – based on individual bank’s share of recovery. Classification independent of member banks However, to see classification status of other bank in case of stressed accounts. 19

20. NPA classification – erosion in value of security/fraud If realisable value is <50% of assessed value – straight away doubtful If realisable value < 10% of outg balance in loan accounts – straight away loss assets. Such accounts need not go through various stages of classification 20

21. Asset classification Housing loans – large single repayment during the year/previous year Agri advances : depends upon crop season (long/short duration) Long – crop season longer than 1 yr crop season – period of harvesting determined by State level committee of banks of each state. 21

22. Asset classification Govt guaranteed advances: state govt = normal classification – 90 days norms Central Govt: only if govt repudiates guarantee when invoked. 22

23. Take over loans Existing classification to be retained. Not healthy to take over NPA loans Provisioning based on original date of becoming NPA, as if it were existed in the books of the bank  Obtain status report from the other bank 23

24. Export projects finance If borrower remitted to bank abroad, but the bank in turn is unable to remit the amount due to political developments such as war, strife, UN embargo, etc. - Not to be treated as NPA, Asset classification starts after 1 year of such remittance  Obtain evidence of remittance directly 24

25. Credit card accounts 90 days norms start from date of next statement Not more than 30 days gap between 2 statements With reference to the minimum due 25

26. Project loans - DCCO The ‘Date of Completion’ and the ‘Date of Commencement of Commercial Operations’ (DCCO), of the project should be clearly spelt out at the time of financial closure of the project and the same should be formally documented. These should also be documented in the appraisal note by the bank during sanction of the loan 26

27. Project loans – Deferment of DCCO is NPA Exceptions: (refer para 4.2.15.3 of MC) if Revised DCCO falls :- Within 2 years of original DCCO for INFRA projects Within 1 year for Other than INFRA projects (including CRE) All other terms and conditions of the loan remain unchanged & Attract standard asset provision of 0.40 % 27

28. Project loans – Deferment of DCCO is NPA Exceptions Continued….. If delay involves involving court cases – additional 2 years (apart from the above 2 years – total 4) If delay due to reasons beyond control of promoters – additional 1 year (total 3) For Non – Infra (other than CRE) – upto to 1 year (total 2) If the a/c continues to service as per restructured terms. 28

29. Project loan – general A project may be classified as NPA during any time before commencement of commercial operations as per record of recovery (90 days overdue) 29

30. Project loan – general The dispensation stated in above is subject to the condition that the application for restructuring should be received before the expiry of normal period of 2/1 year and when the account is still standard as per record of recovery. no change in any other loan conditions Certain other conditions applicable : 30

31. Other conditions: In cases where there is moratorium for payment of interest - banks should not book income on accrual basis beyond 2/1 year/s from the original DCCO for infra/non-infra projects respectively (considering the high risk involved) Banks should maintain additional provisions on such accounts as long as these are classified as standard assets (in addition to provision for diminution in fair value due to extension of DCCO)  Refer page 13 of MC 2015 31

32. Additional provisions chart – ParticularsProvision Projects loans restructured with effect from June 1, 2013: 5.00% from the date of such restructuring till the revised DCCO or 2 years from the date of restructuring, whichever is later Project loans restructured advances after 1.6.2013 3.50 % w.e.f March 31, 2014 (spread over the four quarters of 2013-14) 4.25% w.e.f March 31, 2015 (spread over the four quarters of 2014-15) 5.00 % w.e.f March 31, 2016 (spread over the four quarters of 2015-16) The above provisions will be applicable from the date of restructuring till the revised DCCO or 2 years from the date of restructuring, whichever is later 32

33. Change in DCCO – Concession authority DCCO need not be treated as ‘restructuring’, subject to following conditions: a) The project is an infra project under public private partnership model awarded by a public authority; b) The loan disbursement is yet to begin; c) The revised DCCO is documented by way of a supplementary agreement between the borrower and lender and; d) Project viability reassessed/ sanction obtained from appropriate authority at the time of supplementary agreement. 33

34. Project loans – Change in repayment schedule (para 4.2.15.5 of MC) Any change in the repayment schedule of a project loan caused due to an increase in the project outlay on account of increase in scope and size of the project, would not be treated as restructuring if: (a) The increase in scope and size of the project takes place before commencement of commercial operations of the existing project. (b) The rise in cost excluding any cost-overrun in respect of the original project is 25% or more of the original outlay. (c) The bank re-assesses the viability of the project before approving the enhancement of scope and fixing a fresh DCCO. (d) On re-rating, (if already rated) the new rating is not below the previous rating by more than one notch. 34

35. Project loans – Multiple revision in DCCO Multiple revisions of the DCCO and consequential shift in repayment schedule for equal or shorter duration (including the start date and end date of revised repayment schedule) will be treated as a single event of restructuring provided that the revised DCCO is fixed within the respective time limits stipulated at paragraphs 4.2.15.3 (ii) above, and all other terms and conditions of the loan remained unchanged. 35

36. Restructuring – General All other aspects of restructuring of project loans would be governed by the provisions of Part B of the Master Circular on Prudential norms on Income Recognition, Asset Classification and Provisioning Pertaining to Advances 36

37. Restructuring – to Sum up Refers to change in any terms and conditions Downgraded immediately on restricting (exceptions – deferment of DCCO) Relaxations - only for project loans ( refer para 4.2.15.3 of July 2015 ) No new restricting under earlier restructuring schemes, after 31.03.2015 37

38. Revenue recognition Normally under accrual basis On cash basis for NPA cases Cases of non reversal of URI in NPA (manual/software)- test check Beware of FITL – on cash basis for NPAs 38

39. Provisioning – General - Provisioning norms only for funded exposure Loss -100% (irrespective of security) Doubtful – Unsecured-100% Doubtful – secured - 3 stages Only tangible security considered 39 Period for which the advance has remained in ‘doubtful’ category- Provision requirement % Up to one year25 One to three years40 More than three years100

40. Sub Standard – provision General provision – 15% [security/ECGC cover not to be considered] SS – Unsecured – Additional 10% (total 25%) [‘Unsecured’- Realisable value of security as assessed is not more than 10%, ab initio, of outg exposure - Exposure for this purpose includes funded and non funded] Exception – Infra where escrow account is available – 20% 40

41. Projects under Implementation – Change in Ownership (New) Joint Lenders’ Forum (JLF) can consider such change in ownership under Strategic Debt Restructuring Scheme if the borrower is not able to come out of stress due to operational/ managerial inefficiencies despite substantial sacrifices made by the lending banks fail to achieve the projected viability milestones as per CDR/JLF mechanism - Without affecting the asset classification status 41

42. CDR Multiple banking > Rs. 10 crs exposure SME Debt Restructuring Mechanism upto Rs.10 crs. Date of admission to CDR cell is important (not mere application) Conditions strictly to apply during the period of CDR 42

43. Other points Relying on other inspection/audit reports Flash report/exception report Report on exceeding delegation of authority. Verify the sanction terms fed in software system 43

44. Verification of revenue leakage – Test check Processing charges, insurance, etc Interest on advances, penal interest on overdues (check whether fed in CBS) Charges for non submission/late submission of stock statements, non renewal of limits, charges for inspection/stock audit, valuation etc. 44

45. Symptoms of Stress - Examples Accounts remain mostly above limit Frequent cheque bouncing/dishonour Frequent TOD sanctioned and outstanding Turnover in loan account much lower than purchase/sale of stock Discounted bills remain unrealised Frequent LC devolvement Non submission of stock statements/financials on time Submitted stock statements are not proper and mismatch between audited figures/ stock audit reports Ad – hoc limits/ Delay in renewal of limits Undue delay in commencement of projects Funded/unfunded limits not commensurate with operations Bills discounting disproportionate to operations (accommodation) Specific economic conditions affecting the borrower 45

46. Reports available in CBS Devolvement/ Invoking/ Crystallization Cheque Purchased O/s Borrower Wise Loans- Funded and Non Funded Security Valuation and Provisioning for NPA Account Exceedings Report Sector Wise Exposure SMA lists on various dates Accounts upgraded during the period Fresh sanctions during the period 46

47. PRACTICAL CASES 47

48. Drawing Power - Working capital Periodic inspection by branch officials Stock audits Checking with financials/ VAT Returns Concept of MPBF for computing DP 48

49. DP under MPBF method - Illustration ParticularsAmount (Rs. lacs) Total Value of stocks (clo. Balance of stocks- valued at lower of market rates or cost) A Less: Excess of S. creditors (stock) Excess of S. creditor (others) over the level assumed at the time of assessment BCBC Net value of stockD=A-B-C Eligible Trade debtors including advance for stocks and expenses as envisaged at the time of assessment E Less: Outstanding under Bills discountedF Net value of DebtorsG=E-F Total Eligible Current AssetsH=D+G Less: Stipulated MarginI DRAWING POWER J=H-I 49

50. Drawing power –Illustration- MPBF Method Details of balancesProjected at Assessment- Rs. Lacs Actual Position Inventory10050 Sundry Debtors5025 Other Current Assets5025 Total Current Assets200100 Creditors5040 Other Current Liabilities5020 Net Current Assets10040 Creditors as a % of TCA25%50% Creditors as a % of NCA50%100% 50

51. DP computation ParticularsAmount (Rs.lacs) Inventory as on ….50 Creditors for purchases-Excess Over Original Asmt. 15 Paid stock35 Margin as per sanction - 20%7 DP against stocks (A)28 Debtors25 Debtors more than 90 days5 Eligible debtors20 Margin as per sanction- 30 %6 DP against debtors (B)14 51

52. Credit Appraisal not proper A borrower availed various housing loans from 3 branches in the names of directors/relatives for raising margin for the construction activities of two projects proposed to be financed by the bank - violation of RBI guidelines. The credit appraisal note states various discrepancies such as the track record of the company not being satisfactory, delays in execution of project, discrepancies in the financials, etc. The proposal had serious viability concerns & the company was under financial stress In spite of the same the loan facility was sanctioned. 52

53. IRREGULAR CREDITS & HEALTH MONITORING A borrower enjoys OD and TL facility. Borrower consistently remits interest at the end of each quarter only to regularize the account. These credits were immediately withdrawn by overdrawing the CC limit after the quarter end. There is no operation in the account except for servicing of CC/TL interest/instalments.  Fit case for NPA 53

54. Year end Regularisation The statement of account shows credits and immediate debits and virtually no operational transactions. The borrower services the interest only after repeated persuasion and reminders. (correspondences) Credits in the account which are immediately withdrawn by exceeding the limit, are not accepted as genuine transactions. 54

55. HEALTH MONITORING The debtors as at year end was found to be Rs.190 L (of which debts outstanding for more than 6 months amounted to Rs.100 L) against the sales of Rs. 250 Lacs, indicating high liquidity crunch of the business. Frequent devolvement of LCs and continuous substantial excess over the limit. Accumulated loss increased as per latest financial statements. Borrower made loss during the year also. 55

56. GREENING OF BAD ACCOUNTS Cash Credit account brought within the Limit on the last day of the quarter, by transfer from the current account of a sister concern. To enable this a cheque was purchased in the current account of sister concern. This cheque was subsequently dishonoured. 56

57. GREENING OF BAD ACCOUNTS The OD account was regularized at the end of the quarter through cheque purchases, which were not presented for a number of days. Isolated cash transactions for regularization Term Loan seen serviced through cash, which was brought in by overdrawing the OD/CC account  Verify cash teller a/c of the day for this purpose 57

58. GREENING OF BAD ACCOUNTS -Circuitous transactions Loans to associate concerns to regularize bad accounts, routed through multiple branches  These credits in turn came from current account of another associate concern.  On scrutiny of the account of the said sister concern, it was noticed that the funds credited was out of the fresh general purpose Term Loan sanctioned to the associate concern. 58

59. Computation of Drawing power Consortium Advances – Bank to determine DP based on its own sanction terms and not as per DP allocated by them. Level of DP as per MPBF method to be reassessed by the Bank periodically. 59

60. Areas of concern -Cash credit accounts Sales proceeds not fully routed through the account. Stock statement is not seen an authenticated one Stock statement/bank’s share in consortium not obtained on time by branch. There is no proper system in bank to monitor receipt stock statement/ insurance renewal 60

61. Areas of concern Non compliance/delay in compliance of terms of sanction End use of loan proceeds Branch’s Dependence of 1 or 2 key borrowers Frequent rollovers/extension of export credit Bullet Loans- continuous monitoring during the period Improper credit supervision and monitoring like branch not doing field inspection on time 61

62. Areas of concern Frequent Ad hoc facilities Advances to stressed sectors Persisting audit comments on branch advances Lack of transparency of information Prima facie unacceptable explanations Quick mortality indicate bad appraisal 62

63. THANK YOU radhesh@varmaandvarma.com 63