1. Income Recognition and Asset Classification
M Rama Kumari
AGM & MoF
College of Agricultural Banking
Reserve Bank of India, Pune
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2. Why do we need IRAC Norms ?
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3. What is IRAC
A policy of income recognition on the basis of record of recovery rather than on any subjective considerations.
The classification of assets of banks on the basis of objective criteria ensuring a uniform and consistent application of the norms
Why do we need IRAC norms ?
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4. What is Performing Asset
A performing asset is one which does not disclose any problems and which does not carry more than normal risk attached to the business. Such an asset is classified as Standard Asset
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5. What is Non-Performing Asset
A non performing asset is a loan or an advance where:
(i) interest and/ or installment remain overdue for a period of more than 90 days in respect of a Term Loan
(ii) The amount remains ‘out of order’ for a period of more than 90 days, in respect of an Overdraft/ cash credit
(iii) The bills remains overdue for a period of more than 90 days in case of bills purchased and discounted,
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6. (v) Similar treatment for gold loans granted for agricultural purposes
(iv) In case of direct agricultural advances if the installment of principal thereon remains overdue for more than two crop seasons (in case of short duration crops) and more than one crop season (in case of long duration crop) ; crop pattern as determined by SLBC
(v) Similar treatment for gold loans granted for agricultural purposes
Agriculture loans- crop duration
"long duration" crops would be crops with crop season longer than one year and crops, which are not "long duration" crops would be treated as "short duration" crops.
The crop season for each crop, which means the period up to harvesting of the crops raised, would be as determined by the State Level Bankers' Committee in each state.
Overdue for Agriculture advances
Interest and/or instalment of principal remain overdue for two harvest seasons in case of short duration crops.
A loan granted for long duration crops will be treated as NPA, if the instalment of principal or interest thereon remains overdue for one crop season.
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7. Some exceptions
(vi) Gold loans for non agricultural purposes will have the same treatment like any other loans. However, in case of a Board approved policy and subject to adequate margin gold loan up to Rs.1.0 lakh would not be NPA with bullet repayment option (not exceeding 12 months). It will be NPA only after it is overdue form the date of bullet repayment as fixed by the bank. (Nov.26, 2007)
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8. Some exceptions
(vii) Advances against term deposits, NSCs eligible for surrender, IVPs, KVPs and Life policies need not be treated as NPAs provided adequate margin is available.
(viii) Central Govt. guaranteed accounts need not be treated as NPAs. However, income not to be recognised unless interest/ inatallment is really paid.
(ix) Staff housing loan: as per the due date fixed by the bank, where interest is payable after recovery of principal.
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9. What is an Out of Order A/c
the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. Or
there are no credits continuously for 90 days or
credits are not enough to cover the interest debited during the same period
'out of order‘ means if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for 90 days from or credits are not enough to cover the interest debited during the same period, these accounts should be treated as 'out of order'”.
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10. A few other criteria of classification of CASH CREDIT account as NPA
No monthly stock statement has been submitted by the borrower for last six months (3 months+90 days) or
The Cash Credit account has not been reviewed/ renewed for more than 90 days
Where there is a solitary or a few credit entries before the balance sheet date but the account goes ‘out of order’ thereafter
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11. Classification of Assets
Identification of assets as NPAs should be done on an ongoing basis. Provisions to be made at the end of each calendar quarter.
Charging of interest at monthly rests. However, the date of classification of an advance as NPA shall not change on account of charging of interest at monthly basis
Treatment of NPAs – Borrower-wise not Facility-wise, Bank-wise not borrower-wise
Treatment of Accounts as NPAs: Based on record of recovery; Threat of loss or recoverability is in doubt
Not to treat merely due to existence of some deficiencies which are temporary – non availability of DP, balance exceeding the limit, non submission of stock statements, non renewal of limits on due dates
If regularised by repayment through genunine sources, need not be treated as NPA
But account remain in order subsequently; a solitary credit before B/S date not to be recknoned
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12. Classification of Assets
If the asset is non-performing, the investment in the shares and bonds of the same borrower shall also be classified as NPA.
If the bank is not receiving regular dividend, the investment shall be classified as NPI.
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13. College of Agricultural Banking, RBI, PUNE
ASSET CLASSIFICATION
Sub Standard Assets: The sub standard asset is one which has remained as NPA for a period less than or equal to 12 months.
Provision requirement – 10% of total outstanding irrespective of available security.
However, if there is an erosion in the value of security (less than 50% of the original value as assessed by the bank or accepted by RBI at the time of last inspection) or a fraud has been committed by the borrower, the account will be straight away classified as doubtful category and will attract provision accordingly.
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14. ASSET CLASSIFICATION
Further, if the erosion in the value of security is to the extent that the realisable value of security depletes to less than 10% of the outstanding loan, the account can be straight away classified as ‘Loss’ and provision shall be made accordingly.
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15. Doubtful Asset Doubtful Assets: D I, D II, D III
An asset which has remained NPA for more than 12 months but is less than or upto 24 months is classified in Doubtful I category
Provision required is 20% on secured portion and 100% on unsecured portion
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16. NPA for more than 2 years and up to 4 years
Doubtful Asset
Doubtful II
NPA for more than 2 years and up to 4 years
Provision required is 30% on secured portion and 100% on unsecured portion
Doubtful III
More than 4 years
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17. For T II banks: 100% in case of old D III accounts also.
Doubtful Asset
Provision required:
100% for new (after April 1,2010) D III accounts for both T I banks and T II banks
For T II banks: 100% in case of old D III accounts also.
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18. For T I banks: In case of NPAs(D III) as on March 31, 2010
Doubtful Asset
For T I banks: In case of NPAs(D III) as on March 31, 2010
(i) 60% w.e.f. March 31, 2011
(ii) 75% w.e.f. March 31,2012
(iii)100% w.e.f. March 31, 2013
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19. College of Agricultural Banking, RBI, PUNE
Loss Asset
Loss Assets:
An NPA account where realisable value of security is either nil or is less than 10% of the outstanding. Realisibility is the main criterion not the value of security per se.
Loss asset will attract 100% provision
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20. Internal System for classification of asset
Banks should establish appropriate internal systems to eliminate the tendency to postpone the identification of NPAs , especially in respect of high value accounts.
Responsibility and validation levels for ensuring asset classification may be fixed by the bank
RBI would continue to identify the divergences arising due to non-compliance, for fixing responsibility.
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21. Prudential Guidelines on restructuring of Advances
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22. Prudential Guidelines on Restructuring of Advances
Asset classification norms
As a general rule:
Standard accounts should be immediately reclassified as ‘sub standard assets’ upon restructuring
The non performing asset would slip into further lower asset classification category as per extant asset classification norms with reference to pre restructuring repayment schedule.
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23. Prudential Guidelines on Restructuring of Advances
non-performing assets upon restructuring, would be eligible for up-gradation to the 'standard' category after observation of 'satisfactory performance' during the 'specified period‘ i.e. one year
the asset classification of the restructured account would be governed as per the applicable prudential norms with reference to the pre-restructuring payment schedule.
Any additional finance may be treated as 'standard asset', up to a period of one year after the first interest / principal payment, whichever is earlier, falls due under the approved restructuring package. However, in the case of accounts where the prerestructuring facilities were classified as 'sub-standard' and 'doubtful', interest income on the additional finance should be recognised only on cash basis. If the restructured asset does not qualify for upgradation at the end of the above specified one year period, the additional finance shall be placed in the same asset classification category as the restructured debt.
In respect of loan accounts which enjoy special regulatory treatment as per para , upon restructuring, such non-performing assets would continue to have the same asset classification as prior to restructuring. In case satisfactory performance of the account is not evidenced during the ‘specified period’, it would slip into further lower asset classification categories as per extant asset classification norms with reference to the pre-restructuring repayment schedule.
In case a restructured asset, which is a standard asset on restructuring, is subjected to restructuring on a subsequent occasion, it should be classified as substandard. If the restructured asset is a sub-standard or a doubtful asset and is subjected to restructuring, on a subsequent occasion, its asset classification will be reckoned from the date when it became NPA on the first occasion. However, such advances restructured on second or more occasion may be allowed to be upgraded to standard category after one year from the date of first payment of interest or repayment of principal whichever falls due earlier in terms of the current restructuring package subject to satisfactory performance.
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24. Restructured A/c-Income recognition norms
However, this rule is not applicable in case of (i) Project Financing, (ii) borrowers engaged in important business activities (iii) housing loan
This exceptional treatment is not available to
(i) consumer and personal advances
(ii) Advances to traders
However, in the case of accounts where the prerestructuring facilities were classified as 'sub-standard' and 'doubtful', interest income on the additional finance should be recognised only on cash basis. If the restructured asset does not qualify for upgradation at the end of the above specified one year period, the additional finance shall be placed in the same asset classification category as the restructured debt.
Income recognition norms
(i) The income, if any, generated may be recognised on accrual basis, if FITL is classified as 'standard', and on cash basis in the cases where the same has been classified as a non-performing asset.
(ii) The unrealised income represented by FITL should have a corresponding credit in an account styled as "Sundry Liabilities Account (Interest Capitalization)".
(iii) Only on repayment in case of FITL, the amount received will be recognized in the P&L Account, while simultaneously reducing the balance in the "Sundry Liabilities Account (Interest Capitalisation)".
(e) Special Regulatory Treatment for Asset Classification
In case a restructured asset, which is a standard asset on restructuring, is subjected to restructuring on a subsequent occasion, it should be classified as substandard. If the restructured asset is a sub-standard or a doubtful asset and is subjected to restructuring, on a subsequent occasion, its asset classification will be reckoned from the date when it became NPA on the first occasion. However, such advances restructured on second or more occasion may be allowed to be upgraded to standard category after one year from the date of first payment of interest or repayment of principal whichever falls due earlier in terms of the current restructuring package subject to satisfactory performance.
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25. Restructuring of Agricultural Advances
In case of default in payment of agricultural loans due to natural calamities UCBs on their own may decide to
convert the short term production loan into a long term loan or reschedule the repayment period and
sanction fresh short term loans
these fresh/ restructured loans will not be treated as NPAs and will be governed by fresh terms and conditions
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26. Restructured A/c- Provisioning norms
PRECONDITIONS:
(i)Provision for diminution in the fair value of restructured Advances
Interest sacrifice to be calculated on the basis of discounting present value of cash flow with both pre and post restructuring rate of bank’s BPLR+ appropriate term premium +credit risk premium
Simpler method:5% of the exposure
(ii)The dues of the bank are fully secured with certain exceptions
The erosion in the fair value of the advance should be computed as the difference between the fair value of the loan before and after restructuring. Fair value of the loan before restructuring will be computed as the present value of cash flows representing the interest at the existing rate charged on the advance before restructuring and the principal, discounted at a rate equal to the bank’s BPLR as on the date of restructuring plus the appropriate term premium and credit risk premium for the borrower category on the date of restructuring". Fair value of the loan after restructuring will be computed as the present value of cash flows representing the interest at the rate charged on the advance on restructuring and the principal, discounted at a rate equal to the bank’s BPLR as on the date of restructuring plus the appropriate term premium and credit risk premium for the borrower category on the date of restructuring".
It may please be noted that the above formula moderates the swing in the diminution of present value of loans with the interest rate cycle and will have to be followed consistently in future. No request for changing the same, particularly for reversion to the present formula, will be entertained in future.
Further, it is reiterated that the provisions required as above arise due to the action of the banks resulting in change in contractual terms of the loan upon restructuring which are in the nature of financial concessions. These provisions are distinct from the provisions which are linked to the asset classification of the account classified as NPA and reflect the impairment due to deterioration in the credit quality of the loan. Thus, the two types of the provisions are not substitute for each other.
It is also re-emphasised that the modifications effected to the guidelines on restructuring of advances by RBI are aimed at providing an opportunity to banks and borrowers to preserve the economic value of the units and should not be looked at as a means to evergreen the advances.
In their published annual Balance Sheets for the year ending March 2009, in addition to the disclosures regarding restructured loans required in terms of paragraph 9 of the guidelines enclosed to circular dated March 6, 2009, banks should also disclose the amount and number of accounts in respect of which applications for restructuring are under process, but the restructuring packages have not yet been approved.
In the case of working capital facilities, the diminution in the fair value of the cash credit / overdraft component may be computed as indicated in para above, reckoning the higher of the
1 1
outstanding amount or the limit sanctioned as the principal amount and taking the tenor of the advance as one year. The term premium in the discount factor would be as applicable for one year. The fair value of the term loan components (Working Capital Term Loan and Funded Interest Term Loan) would be computed as per actual cash flows and taking the term premium in the discount factor as applicable for the maturity of the respective term loan components.
In the event any security is taken in lieu of the diminution in the fair value of the advance, it should be valued at Re.1/- till maturity of the security. This will ensure that the effect of charging off the economic sacrifice to the Profit & Loss account is not negated.
The diminution in the fair value may be re-computed on each balance sheet date till satisfactory completion of all repayment obligations and full repayment of the outstanding in the account, so as to capture the changes in the fair value on account of changes in BPLR, term premium and the credit category of the borrower. Consequently, banks may provide for the shortfall in provision or reverse the amount of excess provision held in the distinct account.
If due to lack of expertise / appropriate infrastructure, a bank finds it difficult to ensure computation of diminution in the fair value of advances extended by small branches, as an alternative to the methodology prescribed above for computing the amount of diminution in the fair value, banks will have the option of notionally computing the amount of diminution in the fair value and providing therefor, at five percent of the total exposure, in respect of all restructured accounts where the total dues to bank(s) are less than rupees one crore till the financial year ending March The position would be reviewed thereafter.
The total provisions required against an account (normal provisions plus provisions in lieu of diminution in the fair value of the advance) are capped at 100% of the outstanding debt amount.
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27. Restructured A/cs-Income recognition norms-
Exceptions of (ii)
(a) SSI borrowers where outstanding is up to Rs.25.0 lakh
(b) Infrastructure projects with an escrow account with valid legal claim and where the cash flows generated form the project are adequate for repayment of the advance
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28. Restructured A/cs-Income recognition norms-
WCTL part (created out of irregular principal repayment) may remain unsecured with the condition that a provisioning of 20% would be required on standard restructured asset and for substandard asset it should be 20% in the first year with yearly increase of 20% each subsequent year
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29. Restructured A/cs-Income recognition norms-
(iii)The unit becomes viable in 10 years if it is engaged in infrastructure and in 7 years in case of other units (iv)The repayment period of the restructured advance should not exceed 15 years in case of infrastructure and housing loans 10 years in all other cases.
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30. Restructured A/cs-Income recognition norms-
(v) Personal guarantee is offered by the promoter (except when the unit is affected by external factors pertaining to the economy and industry (vi) The account should not be subjected to repeated restructuring
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31. Restructured A/cs-Income recognition norms-
(vii)Promoter’s additional contribution should not be less than 15% of bank’s sacrifice
(viii) If FITL is created out of unpaid interest, the unrealised income should have a corresponding credit in the account styled as “Sundry Liabilities Account (Interest Capitalisation)”
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32. Other important issues
FITL will be classified in the same category as the restructured advance
The bank should disclose in their published annual Balance Sheet, under ‘Notes on Account’ information relating to number and amount of advances restructured and the amount of diminution in the fair value of advances
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33. College of Agricultural Banking, RBI, PUNE
PROVISIONING NORMS
Rate of Provisioning on Standard Asset:
Loan Type
T II banks
T I banks
Direct advances to Agriculture and SME sector
0.25%
Commercial Real Estate (CRE) sector
1.00%
All other loans and advances not included in (a) and (b) above
0.40%
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34. Thank you
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