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1328The Chartered AccountantMarch 2006
THEME
Prudential Norms On Income
Recognition, Asset Classication And
Provisioning On Advances
P
rudential norms on in-come recognition, assetclassication and pro- visioning (IRAC norms) per-taining to advances portolioso 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 areormulated on the basis o ob- jective criteria rather than onany subjective consideration. This has brought in uniormand 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 Tye
Standard Asset
: The ac-count is not non-perormingand 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 beclassied 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 classication 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 relevantor audit o F.Y.2005-06, auditor will be required to take theaudit steps like Asset Classication, Income Recognition,Provisioning Norms, Restructuring o loans/CDR/Projectunder implementation, Agricultural advances, Classicationo 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.
Overdrat/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 sucient to cover in-terest debited during thesame period. Thus, as on 31st March2006, i any o the above cri-teria is satised, the account would be classied 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 beclassied 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 daysrom 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 veriy the nature/durationo crop circle and accordingly veriy 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 classied as NPA.
Accounts with temporarydefciencies:
Even though criteria laiddown or identication o anaccount as NPA are objective,an account should not be classi-ed as NPA, i the deciencieslike 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 thediculties o large bor-rowers, stock statementsrelied upon by the banksor determining draw-ing power should not beolder than three months. The outstanding in theaccount based on draw-ing power calculatedrom 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 satisactory. Thus, i a borrower is al-lowed drawing on thebasis o stock statemento September’05, the ac-count will be classied asNPA as on 31st March2006.b) Regular and adhoc creditlimits need to be re- viewed/regularised notlater than three monthsrom the due date/dateo ad hoc sanction. Incase o constraints suchas non-availability o -nancial statements andother data rom the bor-rowers, the branch shouldurnish 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 daysrom 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 Lie 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 dened 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 beorethe asset became non-perorming 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 creditacilities sanctioned tothe borrower concerned.ii) In the absence o a clearagreement between thebank and the borroweror the purpose o appro-priation o recoveries inNPAs banks should adoptan accounting principleand exercise the right o appropriation o recover-ies in a uniorm 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 identied assetsas NPA, banks are required toclassiy them urther into ––a) Sub-standard Assetsb) Doubtul 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)
Doubtul Assets:
An asset is classiedas doubtul 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 identiedby 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.
Exceptions:
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 assetclassication. In cases o suchserious credit impairment theasset should be straightaway classied as doubtul or lossasset as appropriate.i) Erosion in the value o se-curity can be reckonedas signicant 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 classiedunder doubtul category and provisioning shouldbe made as applicable todoubtul 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 classied 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 classication 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 thereore,be treated as NPA. I the banksparticipating in the consortium
A loss as-set is onewhere losshas been
identied
by the bankor internalor externalauditorsor the RBIinspectionbut theamount hasnot beenwritten offwholly.
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