INCOME RECOGNITION, ASSET CLASSIFICATION AND

PROVISION ING NORMS FOR THE URBAN COOPERAT IVE BANKS

1. Introduction

As a major element of the Financial Sector Reforms in India, RBI introduced prudential norms for
banking regulation. Capital adequacy, exposure ceilings for lending to individual and group of
borrowers, marking to market of the investment portfolio and, income recognition, asset classification
and provisioning norms for the loan portfolio (IRAC in short) formed the core of prudential regulation.
The IRAC norms serve two primary purposes - (i) to depict the true position of a bank's loan portfolio
and (ii) to help arrest its deterioration. The Committee on Financial System (CFS), under the
Chairmanship of Shri M. Narasimham, recommended a policy of income recognition and asset
classification based on record of recovery and other objective criteria as also provisioning based on the
classification of assets into different categories. RBI largely accepted the recommendations of the CFS
and introduced the IRAC norms for the Urban Cooperative Banks (UCBs) in a phased manner over a
three-year period from the year 1992-93.

2. Income recognition
(i) Effective from April 1, 1992, banks cannot consider as income interest on loan accounts, classified as
Non-Performing Assets (NPA), unless actually received. Such unrealised interest on NPA taken as
income in the earlier year has to be provided for. In other words, income from NPA is booked as income
only when actually received, and not on accrual basis.
(ii) Accrued interest on NPA
Banks should not debit to the borrower’s accounts interest accrued on NPA, but show them
separately under "Interest Receivable Account" and a corresponding amount under "Overdue Interest
Reserve Account" on the assets and liabilities side of the balance sheet respectively. (The amount held in
the Overdue Interest Reserve Account, however, cannot be regarded as a "reserve" or as part of the
owned funds of the Bank as it is not created out of income actually received by the bank).

Sr.No. / UCB Channel / IRAC Norms for UCBs / Aug. 2007 / Eng. / 10 pgs / Version 1
 2

(iii) Accrued interest on performing assets

In respect of loan accounts, classified as performing assets, accrued interest can be debited to the
borrower’s account and taken to income account. If the relevant credit facility becomes NPA later, the
bank should provide for the interest accrued and credited to income account. In such cases, while
making provision the amount held in "Overdue Interest Reserve Account" should be deducted from the
advances outstanding.
(iv) Partial recovery of interest
Banks can take partial recovery of interest on NPA to their income account, provided such recovery
is not out of fresh / additional credit facilities sanctioned to the borrowers concerned.
(v) Income recognition on investments classified as NPA
Investments also are subjected to prudential norms on income recognition. As such, banks should not
take to income interest on accrual basis in respect of any security irrespective of the category in which it
is included, where interest / principal in respect of which is in arrears for more than 90 days.
(vi) Others
Wherever the State Cooperative Societies Acts prescribe a more stringent accounting procedure, the
same should be followed. Further, where the bank has a more stringent accounting procedure, it can
continue to follow such a procedure.

3. Non-performing assets
A credit facility is considered non-performing when it ceases to generate income for the bank. Earlier,
an asset was classified as NPA if interest and / or instalment of principal remained ‘past due’ for a
specific period. ‘Past due’ was replaced by ‘overdue’ with effect from the year ended March 31, 2001.
Any dues to a bank under a credit facility will be overdue if not paid by the due date fixed by the bank.
RBI implemented the 90 days delinquency norm for NPA classification for the UCBs from the year
ended March 31, 2004. Given the heterogeneity of the sector, RBI prescribed relaxed IRAC norms for
smaller UCBs. Details of those relaxations, together with relaxation in provisioning requirements, are in
the Annex. The criteria for treating a loan account as NPA depend on the nature of facility as under:
(i) Term loan:
A term loan is to be classified as NPA if interest and / or principal remained overdue for more than
90 days.

(ii) Cash credit and overdraft account:

A cash credit / overdraft account is classified as NPA if the account is ‘out of order’ for more than 90
days. An account is treated as ‘out of order’ if the balance outstanding is continuously in excess of the
sanctioned limit or drawing power (whichever is lower) or where the outstanding balance in the

Sr.No. / UCB Channel / IRAC Norms for UCBs / Aug. 2007 / Eng. / 10 pgs / Version 1
 3
principal operating account is within the sanctioned limit or drawing power, but there are no credits
continuously for 90 days as on the date of balance sheet, or credits made are not enough to cover the
interest debited during the same period.
(iii) Bills purchased and discounted:
A bill is treated as NPA, if it remains overdue and unpaid for a period of more than 90 days.
Overdue interest should not be charged or taken to income account in respect of overdue bills, unless it
is realised.
(iv) Other credit facilities:
Any other credit facility is to be treated as NPA, if it remains outstanding for a period of more than
90 days.
(v) Agricultural advances:
In case of all direct agricultural advances, effective September 30, 2004 an account should be treated
as NPA if interest and / or instalment of principal remained overdue for two crop seasons from the due
date for short duration crops and one crop season from the due date for long duration crops. Long
duration crops have a crop season longer than one year and crops, which are not long duration crops are
treated as short duration crops. Depending upon the duration of crops raised by a farmer, the above NPA
norms would also be applied to agricultural term loan availed of by him. The crop season for each crop,
which means the period up to harvesting, has to be decided by the State Level Bankers Committee in
each state. In respect of other activities like horticulture, floriculture or allied activities such as animal
husbandry, poultry farming etc., NPA classification would be done on 90 days impairment norm as in
the case of other advances.
Few exceptions
(a) Housing loans to staff members:
Housing loans or similar advances granted to staff members, where interest is payable after recovery
of principal should be classified as NPA only when there is a default in payment of interest on due date.
(b) Project finance:
In the case of project finance, (industrial) where moratorium is allowed for payment of interest /
principal, the respective amounts will become due only after moratorium / gestation period is over.
(c) Credit facilities guaranteed by Government
Credit facilities backed by Central Government guarantee, though overdue, should not be treated as
NPA. Therefore, no provision is required to be made on such accounts. Interest on such advances,
however, should not be taken to income account unless it has been actually realised. From the year
ended March 31, 2006, State Government guaranteed advances and investments in State Government
guaranteed securities would attract extant IRAC norms, if interest and / or principal or any other amount
due to a bank remains overdue for more than 90 days. A bank is not required to invoke the guarantee
before classifying such advances / investments as NPA.

Sr.No. / UCB Channel / IRAC Norms for UCBs / Aug. 2007 / Eng. / 10 pgs / Version 1
 4
(d) Advances against Term Deposits, NSCs etc.
Advances against fixed and other term deposits, National Savings Certificates (NSCs), life policies,
Indira Vikas Patras (IVPs) and Kisan Vikas Patras (KVPs) need not be treated as NPA although interest
thereon is not paid. Interest on such advances may be taken to income account on the due dates,
provided adequate margin is available in the accounts.
(e) Advances affected by natural calamity
Where natural calamities impair the repaying capacity of the agricultural borrower, UCBs may
consider i) converting the crop loan in to an agricultural term loan or rescheduling the repayment period
and ii) sanctioning fresh short-term loans. In such cases, the term loan or the fresh short-term loan will
be treated as current dues and need not be classified as NPA. Asset classification of these loans will be
governed by the revised terms and conditions and these would be classified as NPA as per the extant
norms applicable for classifying agricultural advances as NPA.

4. Asset Classification
In order to facilitate assessment of quality of the advances portfolio and to enable them to make
adequate provisions, the UCBs should classify loan assets into the following categories.
CATEGORY FEATURE
1 Standard Assets, which do not disclose any problem and do not carry more
than the normal risk attached to the business. Such assets are not
NPA.
2 Sub-standard Effective from year ended March 31, 2005, assets are classified sub-
standard if they remain non-performing for less than or equal to 12
months. They have well defined credit weaknesses and are
characterised by the distinct possibility that the bank will sustain
some loss if the deficiencies are not rectified.

Sr.No. / UCB Channel / IRAC Norms for UCBs / Aug. 2007 / Eng. / 10 pgs / Version 1
 5

An account, where the terms of loan agreement relating to payment

3 Doubtful
4 Loss
of interest and repayment of principal have been negotiated or
rescheduled after commencement of production, should be classified
as sub-standard and retained as such for at least one year of
satisfactory performance under the renegotiated terms.
Effective from year ended March 31, 2005, assets are classified
doubtful if they remain non-performing for more than 12 months.
They have all the weaknesses inherent in sub-standard assets with the
added characteristic that collection or liquidation of the dues is highly
improbable. As in the case of sub-standard asset, rescheduling does
not entitle a bank to upgrade the quality of the account automatically.
These are assets where loss has been identified by the bank or
internal / external auditors or RBI inspection, but the amount has not
been written off, wholly or in part. Such assets are considered
uncollectible and of so little value that their continuance as bankable
assets is not warranted, even though there may be some salvage or
recovery value.

5. Guidelines for asset classification

Assets are to be classified generally on the basis of well-defined credit weaknesses and the extent of
dependence on collaterals for realisation of dues. Net worth of borrower / guarantor should not be taken
into account while determining whether an advance is NPA. Banks should bear in mind the following
RBI guidelines for asset classification.
(i) Identification of assets as NPA on on-going basis
Banks should identify assets as NPA on an on-going basis. They should evolve a system to eliminate
the tendency to delay or postpone identification of NPA, particularly in respect of high-value accounts.
They should internally resolve doubts regarding asset classification within one month of the date by
which the account would have been classified as NPA as per prescribed norms.
(ii) Treatment of accounts as NPA
a) Record of recovery
The classification of an asset as NPA has to be done on the record of recovery. Banks should not
classify an account as non-performing due to the existence of ‘temporary deficiencies’ such as balance
exceeding limit, non-availability of adequate drawing power, non-submission of stock statement or
non-renewal of accounts on due date. If an account is
regularised before the balance sheet date by repayment of overdue through genuine sources (not by
sanction of additional facilities or transfer of funds between accounts), the account need not be treated as
NPA. It should, however, be ensured that the account remains in order subsequently and a solitary credit
made in the accounts near about the balance sheet date to extinguish the overdue interest or instalment
of principal is not reckoned as the sole criterion for treating the account as a standard asset. In other
genuine cases, banks must furnish to the Statutory Auditor / RBI Inspecting Officer satisfactory
evidence of regularisation of the account.

Sr.No. / UCB Channel / IRAC Norms for UCBs / Aug. 2007 / Eng. / 10 pgs / Version 1
 6
b) Borrower-wise and not facility-wise
Where one credit facility extended to a borrower becomes NPA, all the other facilities, even if the
operations in those accounts are satisfactory, are required to be treated as NPA.
(iii) Potential threats to recovery
In respect of accounts where there are potential threats to recovery on account of erosion in the value
of security or existence of factors such as frauds committed by borrowers, such accounts should be
straightway classified as doubtful or loss asset, as the case may be, irrespective of the period for which
they have remained as NPA. Similar treatment should be provided to accounts where there is significant
erosion in value of security, i. e. less than 50% of the value assessed by the bank or accepted by RBI at
the time of last inspection.
(iv) Classification as NPA for arrears in submission of stock statements
Outstanding in the account based on drawing power calculated from stock statements older than
three months would be considered as irregular. A working capital account will be classified as NPA if
such irregular drawings are allowed for more than 90 days.
(v) Classification as NPA for non-review or non-renewal of limits
An account where regular / ad-hoc credit limits are not reviewed or not renewed within 90 days from
the due date or date of ad-hoc sanction will be classified as NPA.
(vi) Treatment of loss assets
If the realizable value of the security, as assessed by the bank or approved valuer or RBI, is less than
10% of the outstanding in the borrower’s account, existence of security should be ignored and the
account should be classified straightway as a loss asset.
(vii) Classification of accounts under consortium
Asset classification of accounts under consortium will be done on the record of recovery in
individual banks. However, where remittances by the borrower under consortium lending arrangements
are pooled with one bank, and that bank does not part with the share of a member bank, the account in
the member bank will be treated as not having been serviced and will be treated as NPA as per extant
norms.
(viii) Fixing realistic repayment schedules
UCBs should fix monthly / quarterly instalments for repayment of gold loans for non-agricultural
purposes after taking in to account the income generation pattern and repayment capacity of the
borrower. Such gold loans should be classified as NPA if interest and / or instalment remain overdue for
more than 90 days. In case of gold loans for agricultural purpose, interest has to be charged at yearly
intervals as per the Supreme Court judgement and payment should coincide with harvesting. Such
advances will be NPA only if instalment and / or interest become overdue after the due date.

5. Provisioning

Sr.No. / UCB Channel / IRAC Norms for UCBs / Aug. 2007 / Eng. / 10 pgs / Version 1
 7
(i) In conformity with prudential norms, UCBs should make provisions on the NPAs based on
classification of assets in to prescribed categories as detailed in paragraph 4 above. Considering the time
lag between an account becoming doubtful of recovery, its recognition as such, the realisation of the
security and erosion in the value of security over time, banks are required to make provisions as detailed
below against loss, doubtful and sub-standard assets:

Asset category Provision required

1 Loss The bank should write off the entire outstanding. Otherwise, it has to
make 100% provisioning for the outstanding.
2 Doubtful (a) 100% of the portion not covered by the realisable
value of security
(b) Over and above item (a) depending upon the period
up to which the asset has remained doubtful, 20% -
100% of the secured portion (i.e. estimated realisable
value) as given below:
Period Provision %
Up to 1 year 20
1 – 3 years 30
Over 3 years i) 50 up to
Outstanding stock of NPA as on March 31, 2007 31.3. 2007
ii) 60 as on
31. 3. 2008
iii) 75 as on
31. 3. 2009
iv) 100 as on
31. 3. 2010
Advances classified as ‘doubtful for more than 100
three years’ on or after April 1, 2007
3 Sub-standard A general provision of 10% on total outstanding

ii) Provision on Standard Assets

UCBs were required to make a general provision of 0.25% on standard assets from the year ended
March 31, 2000. The general provisioning requirement on standard assets, barring UCBs’ direct advance
to agriculture and SME sector, was raised to 0.40% in November 2005. In order to ensure maintenance
of asset quality in the context of high credit growth, RBI raised the general provisioning requirement for
UCBs on standard advances in respect of personal loans, loans and advances qualifying as capital
market exposure and commercial real estate loans from 0.40% to 1.0% in June 2006. Certain categories
of loans continued to experience high growth; personal loans witnessed a higher default rate. Therefore,
provisioning requirement in respect of personal loans, loans and advances qualifying as capital market
exposure and commercial real estate loans (excluding residential housing loans) was raised from 1% to
2% in February 2007. Simultaneously, RBI decided to increase provisioning for loans and advances to
Non-Deposit Taking Systematically Important Non-Banking Finance Companies (NBFC-ND-SI) from
0.40% to 2% (A systematically important NBFC is defined as an Non-Deposit Taking NBFC with an

Sr.No. / UCB Channel / IRAC Norms for UCBs / Aug. 2007 / Eng. / 10 pgs / Version 1
 8
asset size of Rs.100.00 crore or more as per the last audited balance sheet). The standard asset
provisioning requirements for UCBs, after the above changes, stand as summarized below:

Sr. No. Category of standard asset Provisioning

percentage
(a) Direct loans to agriculture and SME sectors 0.25%
(b) Personal loans, loans qualifying as capital market exposure, commercial 2.00%
real estate loans (excluding residential housing loans) and loans and
advances to NBFC-ND-SI
(c) All other loans and advances not included under (a) and (b) above 0.40%

The provision towards ‘standard assets’ need not be netted from gross advances but should be shown
separately as ‘Contingent Provision towards Standard Assets’ under ‘Other Funds and Reserves’ in the
Balance Sheet. In case a bank is having provision in excess of what is required for non-performing
assets under Bad & Doubtful Debt Reserve (BDDR), additional provision required for standard assets
may be segregated from BDDR and parked under ‘Contingent Provision towards Standard Assets’ with
the approval of the Board of Directors. This contingent provision will be available for inclusion in Tier
II capital.
(iii) Guidelines for Provisions
a) Advances covered by DICGC / ECGC guarantee
In respect of advances guaranteed by ECGC/DICGC, provisioning is to be made only for the
balance exceeding the amount of guarantee. Further, while arriving at the provision for Doubtful
assets, realisable value of the securities should be deducted from the outstanding balance before the
guarantee is set off.
b) Additional facilities under rehabilitation package
If under a rehabilitation package approved by BIFR / term lending institution, banks allow
additional credit facilities to a unit, which has been categorised as sub-standard or doubtful, they
need not make provisions for a period of one year from the date of disbursement of such additional
facilities. Similar treatment should be made in respect of sick SSI units under a nursing programme.
However, banks should make provisions on existing credit facilities classified as sub-standard or
doubtful in both the cases.

Sr.No. / UCB Channel / IRAC Norms for UCBs / Aug. 2007 / Eng. / 10 pgs / Version 1
 9
c) Certain advances exempted
Advances against banks’ own term deposits, NSCs, KVPs, IVPs and life policies are exempted
from provisioning requirements. However, advances against gold ornaments, government securities
and all other securities attract provisioning.
d) Valuation of security
To have uniform assessment of valuation of security and reduce divergence in provisioning
requirements, banks should undertake annual stock audit of current assets by external agencies in
respect of NPAs with balance of Rs.10.00 lakh and above. Besides, immoveable property
charged to the bank should be valued once in three years by the bank’s approved valuers.

ANNEX
Relaxed Prudential Norms on Asset Classification and
Provisioning for certain categories of UCBs

Unit banks i.e. banks having a single branch / Head Office with deposits up to Rs.100 crore and banks
having more than one branch within a single district with deposits up to Rs.100 crore are exempted from
the extant asset classification and provisioning norms as under:

Sr. Extant Norm Relaxed Norm Remarks

No.
1. Asset classification norm:
i) With effect from the year
ended March 31, 2004 the
norm for classification on an
asset as NPA has been reduced
to 90 days from 180 days
ii) With effect from the year
ended March 31, 2005 an asset
would be classified as doubtful
if it remained in the sub-
standard category for 12
months
2. Provisioning norms
i) General provisioning
requirement on standard assets
(excepting direct agriculture
and SME) raised from 0.25%
to 0.40% and to 2% on specific
sectors
ii) 100% provisioning on
secured portion of advances
classified as Doubtful III on or
after April 1, 2007
These banks will continue to
identify NPAs based on 180-
day delinquency norm for
three more years commencing
March 31, 2005, i.e. up to
March 31, 2007.
A sub-standard account will
continue to be classified as
doubtful after 18 months
instead of 12 months up to
March 31, 2007.
General provisioning
requirement on standard assets
continue to remain at 0.25%
for the exempted banks.
100% provisioning to be made
by the exempted banks on
secured portion of advances
classified as Doubtful III on or
The 180-day delinquency
norm for NPAs has since been
extended by one more year
i.e. up to March 31, 2008.
The 12-month period for
classification of a sub-
standard asset in doubtful
category has since been
extended by one more year
i.e. up to March 31, 2008.
-
-

Sr.No. / UCB Channel / IRAC Norms for UCBs / Aug. 2007 / Eng. / 10 pgs / Version 1

iii) For the outstanding stock
of D-III advances as on
March 31, 2007 banks would
be required to provide as
under:
10
after April 1, 2010.
For the outstanding stock of D-
III advances as on March 31,
2010 the exempted banks
would be required to provide
as under:

50% up to March 31, 2007 50% up to March 31, 2010

-
60% as on March 31, 2008 60% as on March 31, 2011

75% as on March 31, 2009 75% as on March 31, 2012

100% as on March 31, 2010 100% as on March 31, 2013

Prepared by Dr Sujata Elizabeth Prasad, Member of Faculty

Revised by Shri B. Raghavendran, Member of Faculty
Updated by Shri R. R. Borbora, Member of Faculty (May 2007)

Sr.No. / UCB Channel / IRAC Norms for UCBs / Aug. 2007 / Eng. / 10 pgs / Version 1