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1328The Chartered AccountantMarch 2006
Prudential Norms On Income
Recognition, Asset Classication And
Provisioning On Advances
rudential norms on in-come recognition, assetclassication and pro- visioning (IRAC norms) per-taining to advances portolioso banks were introduced orthe rst time by Reserve Bank o India during nancial year1992-93 i.e. year ended 31stMarch 1993 in line with theinternational practices. The prudential norms areormulated on the basis o ob- jective criteria rather than onany subjective consideration. This has brought in uniormand consistent application o the norms and greater trans-parency in published accountso banks.Reserve Bank o India hasbeen issuing Master Circu-lars on prudential norms orpast ew years. Last Mastercircular on prudential normspertaining to advances was is-sued by Reserve Bank o In-dia on 1st July 2005.
Asset Tye
Standard Asset
: The ac-count is not non-perormingand does not carry more thannormal risk attached to thebusiness.
Non-Performing Asset(NPA)
: An asset becomesNPA when it ceases to gener-ate income or the bank. This would mean that interest, which is debited to borrower’saccount, has to be realised by the bank. An account has to beclassied as NPA on the basiso record o recovery ratherthan security charged in a- vour o the bank in respecto such account. Thus, an ac-count o a borrower may be-come NPA i interest chargedto that particular borrower isnot realised despite the ac-count being ully secured.
Identification Of AccountAs NpA
RBI has laid down variouscriteria or classication o vari-ous types o advances as NPA which are as under:
Term Loan
: Interest and /orinstalment o principal remainoverdue or a period o morethan 90 days.For bank branch audits the auditors have to keep them-selves abreast o the applicable IRAC norms incorporated inthe RBI’s Master Circular dated 1st July 2005. On the basiso the guidelines provided in this circular which are relevantor audit o F.Y.2005-06, auditor will be required to take theaudit steps like Asset Classication, Income Recognition,Provisioning Norms, Restructuring o loans/CDR/Projectunder implementation, Agricultural advances, Classicationo NPA borrower-wise and not acility-wise, Upgradation o Account From NPA to Standard and Regularisation o ac-count at near about balance sheet date.This article discussessalient eatures and some o the practical aspects o prudentialnorms pertaining to advances o banks.One will have to determinethe due date o interest and in-stalment. I either interest orinstalment is overdue or morethan 90 days then the account would become NPA. Interestor instalment, which is due ason 30th December, would beoverdue or more than 90 daysas on 31st March 2006 and theaccount would become NPA.However, i the same was dueon 31st December 2005, thenthe account would not becomeNPA as on 31st March 2006.
Overdrat/Cash Credit 
: I an account remains out o or-der, it would become NPA. Forthis purpose an account wouldbe treated as ‘out o order’ i:i) The outstanding balanceremains continuously inexcess o the sanctionedlimit/drawing power or90 days or more, orii) Even i the outstandingin the account is less thanthe sanctioned limit/drawing power, there areno credits in the accountcontinuously or 90 daysas on the date o the Bal-ance sheet, oriii) Credits in the account arenot sucient to cover in-terest debited during thesame period. Thus, as on 31st March2006, i any o the above cri-teria is satised, the account would be classied as NPA. There may be a situation wheresay or example drawing powero an account is Rs.10 lacs, bal-ance is Rs.8 lacs and there areno credits in the account or 90days. Such account would beclassied as NPA.
The author is member of the Institute. He can be reached at choksi.vipul@ gmail.com
Vipul K.Choksi
The Chartered Accountant 1329March 2006
 Bills Purchased/Discounted 
:I the bills purchased or dis-counted remains overdue ora period o more than 90 daysrom its due date.
 Agricultural Advances: aloan granted or 
i) Short duration crops willbe treated as NPA, i theinstallment o principal orinterest thereon remainsoverdue or two crop sea-sons.ii) Long duration crops willbe treated as NPA, i theinstallment o principal orinterest thereon remainsoverdue or one cropseason.For the purpose o theseguidelines, “long duration”crops would be crops with cropseason longer than one year andcrops, which are not “long du-ration” crops would be treatedas “short duration” crops. Thus an auditor will haveto veriy the nature/durationo crop circle and accordingly  veriy whether an agriculturalaccount is NPA as on 31stMarch 2006.
Other Credit Facility:
Incase o any other credit acil-ity, i the amount to be receivedremains overdue or more than90 days, then the account willbe classied as NPA.
 Accounts with temporarydefciencies:
Even though criteria laiddown or identication o anaccount as NPA are objective,an account should not be classi-ed as NPA, i the deciencieslike non-submission o stock statement and, non-renewal o acility in the account are tem-porary in nature. RBI guide-lines in this regard as under.a) Drawing power is re-quired to be arrived atbased on the stock state-ment, which is current.However, considering thediculties o large bor-rowers, stock statementsrelied upon by the banksor determining draw-ing power should not beolder than three months. The outstanding in theaccount based on draw-ing power calculatedrom stock statementsolder than three months, would be deemed as ir-regular. A working capi-tal borrowal account willbecome NPA i such ir-regular drawings are per-mitted in the account ora continuous period o 90days even though the unitmay be working or theborrower’s nancial posi-tion is satisactory. Thus, i a borrower is al-lowed drawing on thebasis o stock statemento September’05, the ac-count will be classied asNPA as on 31st March2006.b) Regular and adhoc creditlimits need to be re- viewed/regularised notlater than three monthsrom the due date/dateo ad hoc sanction. Incase o constraints suchas non-availability o -nancial statements andother data rom the bor-rowers, the branch shouldurnish evidence to show that renewal/review o credit limits is already onand would be completedsoon. In any case, delay beyond six months is notconsidered desirable as ageneral discipline. Hence,an account where the reg-ular/ adhoc credit limitshave not been reviewed/renewed within 180 daysrom the due date/dateo ad hoc sanction will betreated as NPA.
Income Recognition
i) Income rom NPA isnot recognised on ac-crual basis but is bookedas income only when it isactually received. There-ore interest on any NPAshould not be recognizedunless realized.However, interest on ad- vances against term de-posits, NSCs, IVPs, KVPsand Lie policies may betaken to income accounton the due date, providedadequate margin is avail-able in the accounts.For example: A borrowerhas taken loan o Rs.1lac against term deposito Rs.1.25 lacs. Balancein the account as on 31stMarch’06 is Rs.1.10 lacs.Even though account isover drawn, income wouldbe recognized since valueo deposit is more thanthe balance outstanding.ii) Fees and commissionsearned by the banks as aresult o re-negotiationsor rescheduling o out-standing debts should berecognised on an accrualbasis over the period o time covered by the re-negotiated or rescheduledextension o credit.iii) I Government guaran-teed advances becomeNPA, the interest on suchadvances should not betaken to income accountunless the interest hasbeen realised.
 Reversal o income
i) I any advance, includingbills purchased and dis-counted, becomes NPAas at the close o any year,interest accrued and cred-ited to income account inthe corresponding previ-ous year, should be re- versed or provided or i the same is not realizedduring the year underaudit. This will apply toGovernment guaranteedaccounts also.
Regularand ad-hoc creditlimits needto bereviewed/regularisednot laterthan threemonthsfrom thedue date/date of adhocsanction.
1330The Chartered AccountantMarch 2006
ii) In respect o NPAs, ees,commission and similarincome that have accruedshould cease to accrue inthe current period andshould be reversed orprovided or with respectto past periods, i uncol-lected.iii) The nance charge com-ponent o nance in-come [as dened in AS19 – Leases’ issued by theCouncil o the Instituteo Chartered Accoun-tants o India (ICAI)] onthe leased asset which hasaccrued and was creditedto income account beorethe asset became non-perorming and remainunrealised, should be re- versed or provided or inthe current accountingperiod.
 Appropriation o recovery in NPAs
i) Interest realised on NPAsmay be taken to incomeaccount provided thecredits in the accounts to- wards interest are not outo resh/additional creditacilities sanctioned tothe borrower concerned.ii) In the absence o a clearagreement between thebank and the borroweror the purpose o appro-priation o recoveries inNPAs banks should adoptan accounting principleand exercise the right o appropriation o recover-ies in a uniorm and con-sistent manner. Thus, asper the consistent policy o the bank recovery may be appropriated towardsinterest or principal.iii) As per income recogni-tion norms, bank cannotrecognise income unlessrealised. However, bank can debit interest to NPAaccount provided it iscredited to interest sus-pense account.
Asset Classification
Having identied assetsas NPA, banks are required toclassiy them urther into ––a) Sub-standard Assetsb) Doubtul Assetsc) Loss Assetsi)
Sub-standard Assets:
A sub-standard asset isone, which has remainedNPA or a period o less than or equal to 12months.ii)
Doubtul Assets:
An asset is classiedas doubtul i it has re-mained in the sub-stan-dard category or a periodo 12 months.iii)
Loss Assets:
A loss asset is one whereloss has been identiedby the bank or internalor external auditors orthe RBI inspection butthe amount has not been written o wholly. Inother words, such an as-set is considered uncol-lectible and o such little value that its continuanceas a bankable asset is not warranted although theremay be some salvage orrecovery value.
In respect o accounts wherethere are potential threats orrecovery on account o ero-sion in the value o security ornon-availability o security andexistence o other actors suchas rauds committed by bor-rowers, it will not be prudentthat such accounts should gothrough various stages o assetclassication. In cases o suchserious credit impairment theasset should be straightaway classied as doubtul or lossasset as appropriate.i) Erosion in the value o se-curity can be reckonedas signicant when therealisable value o the se-curity is less than 50 percent o the value assessedby the bank or acceptedby RBI at the time o lastinspection, as the casemay be. Such NPAs may be straightaway classiedunder doubtul category and provisioning shouldbe made as applicable todoubtul assets.ii) I the realisable value o the security, as assessedby the bank/approved valuers/RBI is less than10 per cent o the out-standing in the borrowalaccounts, the existence o security should be ignoredand the asset should bestraightaway classied asloss asset. It may be either written o or ully pro- vided or by the bank.
Asset Classification– SomeClarifications:
(i) Asset Classifcation to be borrower-wise and not acility-wise 
All the acilities granted by a bank to a borrower and in- vestment in all the securities is-sued by the borrower will haveto be treated as NPA/NPI andnot the particular acility/in- vestment or part thereo whichhas become irregular.
(ii) Advances under consortiumarrangements
Asset classication o ac-counts under consortium shouldbe based on the record o recov-ery o the individual memberbanks and other aspects havinga bearing on the recoverabil-ity o the advances. Where theremittances by the borrowerunder consortium lending ar-rangements are pooled withone bank and/or where thebank receiving remittances isnot parting with the share o other member banks, the ac-count will be treated as not ser- viced in the books o the othermember banks and thereore,be treated as NPA. I the banksparticipating in the consortium
A loss as-set is onewhere losshas been
by the bankor internalor externalauditorsor the RBIinspectionbut theamount hasnot beenwritten offwholly.

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Day today updation is required. After, the account become NPA, what are steps to be taken by a banker. Loknath Sahoo Mumbai
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I was interested to find the guidelines for 2nd restructuring of Debts and its installment reschedulements for payments for a Textile Industry the RBI norms for the classifications of the assets.
Kamalesh Shukla added this note
Well written and usfull. Some updation be needed for current year 2012.
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useful information
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