V Seshadri

Meeting expectation of all stakeholders in a banking business entity Stakeholders in a banking business are
Shareholders Regulator Investors Customers-Internal & External

In PSU bank, Government of India is a major shareholder owning equity of 51% or more. GOI had appointed RBI as regulator of banking industry Following guidelines of RBI is must for meeting expectation of stakeholders in PSU banks

RBI Governor Subbarao article in DNA on 1712-2011has stated the following

CA profession has shied away from its responsibility in relation to prevention & early detection of frauds & has warned that other agencies could displace auditors if CAs were not willing to provide such services, depriving them of a potentially expanding opportunity It was possible to reduce the frequency with which public sector banks (PSBs) are audited by using technologies such as core banking & centralised record keeping

 Currently the cost of audit of PSBs is significantly higher than the cost of audit of comparable private sector banks. However, the institute has been resisting this because it would mean a reduction in work for its members He also drew attention to differences in identification of NPAs by the supervisory inspection conducted by RBI & certified auditors.
In RBIs view, in certain cases, the statutory auditors have underestimated the extent of NPAs & required provisioning. Since RBI, as the supervisor of the banking system, relies & leverages on the work done by auditors, the profession should effectively address this issue

Priority Sector classification Loans to Directors, interested firms Loans against Gold and bullion NPA classification and NPV provisioning Restructuring of advances not meeting Special Regulatory Treatment especially viability Reversal of income from NPA Devolvement of LCs/ invocation of BGs

Overdue
Any amount due to the bank under any credit facility is overdue if it is not paid on the due date fixed by the bank

Out of Order status

An account should be treated as out of order
if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power

OR
In circumstances 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 as on the date of Balance Sheet of the bank

OR
The credits are not enough to cover the interest debited during the same period

If any advance, including bills purchased and discounted, becomes NPA, the entire interest accrued and credited to income account in the past periods, should be reversed if the same is not realised. This will apply to Government guaranteed accounts also. In respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in the current period and should be reversed with respect to past periods, if uncollected. Leased Assets: The finance charge component of finance income [as defined in AS 19 Leases issued by the Council of the Institute of Chartered Accountants of India (ICAI)] on the leased asset which has accrued and was credited to income account before the asset became nonperforming, and remaining unrealised, should be reversed or provided for in the current accounting period.

If arrears of interest and principal are paid by the borrower in the case of loan accounts classified as NPAs, the account should no longer be treated as non-performing and may be classified as standard accounts. With regard to upgradation of a restructured/ rescheduled account which is classified as NPA contents of paragraphs 11.2 and 14.2 in the Part B of RBI Master circular will be applicable.

Restructuring of advances could take place in the following stages :

before commencement of commercial production / operation; after commencement of commercial production / operation but before the asset has been classified as 'sub-standard'; after commencement of commercial production / operation and the asset has been classified as 'substandard' or 'doubtful'.

The accounts classified as 'standard assets' should be immediately re-classified as 'substandard assets' upon restructuring.

The non-performing assets, upon restructuring, would continue to have the same asset classification as prior to restructuring and slip into further lower asset classification categories as per extant asset classification norms with reference to the pre-restructuring repayment schedule. All restructured accounts which have been classified as nonperforming assets upon restructuring, would be eligible for up-gradation to the 'standard' category after observation of 'satisfactory performance' during the 'specified period (Specified Period means a period of one year from the date when the first payment of interest or instalment of principal falls due under the terms of restructuring package) In case, however, satisfactory performance after the specified period is not evidenced, 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 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.

The special regulatory treatment for asset classification, in modification to the provisions in this regard will be available to the borrowers engaged in important business activities, subject to compliance with certain conditions as enumerated. Such treatment is not extended to the following categories of advances:
Consumer and personal advances; Advances classified as Capital market exposures; Advances classified as commercial real estate exposures

The special regulatory treatment has the following two components:

Incentive for quick implementation of the restructuring package. Retention of the asset classification of the restructured account in the pre-restructuring asset classification category

For all projects financed by the FIs/ banks after 28th May, 2002, the date of completion of the project should be clearly spelt out at the time of financial closure of the project. All project loans have been divided into the following two categories :
'Project Loan' would mean any term loan which has been extended for the purpose of setting up of an economic venture.
Project Loans for infrastructure sector Project Loans for non-infrastructure sector

Standard Assets

Banks are required to make general provisions for standard assets for the funded outstanding on a global portfolio basis. These provisions which are in the range of 0.25% to 1.00% on the outstanding loans are required and are based on the type of exposure. Provisions for housing loans at teaser rates would be 2.00% and will reduce to 0.40% after one year from the date on which the teaser rates are reset at higher rates if the accounts remain standard. Derivative exposures, such as credit exposures computed as per the current marked to market value of the contract arising on account of the interest rate and foreign exchange derivative transactions and gold shall also attract the provisioning requirement applicable to the loan assets in the standard category, of the concerned counterparties. All conditions applicable for the treatment of the provisions for standard assets would also apply to the aforesaid provisions for derivatives and gold exposures.

Sub Standard Assets

A general provision of 15.0% on total outstanding loans is required without making any allowance for the Export Credit Guarantee Corporation of India (ECGC) guarantee cover and securities available. The unsecured exposures which are identified as sub-standard would be subject to an additional provision of 10.0% (i.e. a total of 25.0% on the outstanding balance). However, unsecured loans classified as sub-standard, where certain safeguards such as escrow accounts are available, will attract an additional provision of 5.0% (i.e. a total of 20.0% on the outstanding balance).

Unsecured exposure is defined as an exposure where the realizable value of security, as assessed by the bank, approved valuers and the RBIs inspecting officers, is not more than 10.0%, ab-initio, of the outstanding exposure. Exposure shall include all funded and nonfunded exposures (including underwriting and similar commitments). Security will mean tangible security properly discharged to the bank and will not include intangible securities such as guarantees and comfort letters.

Doubtful assets

A 100.0% provision is made against the unsecured portion of the doubtful asset. The value assigned to the collateral securing a loan is the realizable value determined by third party appraisers. In cases where there is a secured portion of the asset, depending upon the period for which the asset remains doubtful, a 25.0% to 100.0% provision is required to be made against the secured asset as follows: Up to one year: 25.0% provision One to three years: 40.0% provision More than three years: 100.0% provision

Loss assets

The entire asset is required to be written off or provided for. In June 2006, the RBI issued prudential standards on the creation and utilization of floating provisions (provisions which are not made in respect of specific non-performing assets or are made in excess of regulatory requirements for provisions for standard assets). The standards state that floating provisions can be used only for contingencies under extraordinary circumstances for making specific provisions in impaired accounts after obtaining approval from the banks board of directors and with the prior permission of the RBI. Floating provisions must be held separately and cannot be reversed by credit to the profit and loss account. Until the utilization of such provisions, they can be netted off from gross nonperforming assets to arrive at disclosure of net non-performing assets, or alternatively, can be treated as part of Tier II capital within the overall ceiling of 1.25% of total risk-weighted assets. We have elected to treat floating provisions as part of Tier II capital. Further, floating provisions would not include specific voluntary provisions made by banks for advances at rates which are higher than the stipulated rates and consistently adopted from year to year.

With a view to ensuring counter-cyclical provisioning in the banking system, the RBI has mandated that banks should augment their provisioning cushions consisting of specific provisions against NPAs as well as floating provisions (to the extent not used at Tier II capital), and ensure that their total Provisioning Coverage Ratio (PCR), including the above floating provisions, is not less than 70.0%. The surplus of provisions under the PCR vis--vis that required as per prudential specific provisioning norms is styled as a counter-cyclical buffer.

A provision is made equal to the net present value of the reduction in the rate of interest on the loan over its maturity

Points in RBI audit Housing loan policy of bank permitted sanction of housing loans to nonindividual constitutions Bank had classified buyout loans as PSL on the basis of outstanding Claims not acknowledged as debt- Impact of court decision

RBI audit comments / suggestions Sanction of housing loans to entities which were not natural persons was considered inappropriate & was not in line with RBI master circular on Housing finance. Accordingly, the reporting was to be revised & internal classification of bank also needed to be amended PSL classification need to be done based on original limit amount sanctioned by the Bank/FI from whom portfolio was bought & as such the eligibility of such classification as PSL was not ascertainable. In six cases it was observed that the decision had gone against the bank in lower court & the bank had filed appeal in the upper court. In view of this position, additional provision was suggested

Actuals
Date
30-3-11 30-6-11 30-9-11 30.00

Should have been

LC
20.00 Devolved 0.00 30.00

CC
30.00

Total
50.00

Date
30-3-11 30-6-11 30-9-11

CC
30.00

LC
20.00 Devolved

Total
50.00

50.00

0.00

50.00

The banks credit policy had not prescribed the process to be followed for monitoring & asset classification in case of devolvement of LCs. The bank parked each devolved LC in a separate account for ease of monitoring. While calculating the outstanding for the borrower, the devolved amount outstanding was not reckoned together with principal operating account for asset classification. The case the outstanding in the principal operating account taken with the outstanding due to devolved LCs exceeded fund based limit of the borrower, the account was classified as NPA

1. Loans against equitable mortgage of property under Home Equity product 2.No primary security 3. Only collateral security of land & building 4. Loans were treated as part of regulatory retail & risk weight of 75% was applied 5. On above basis, portfolio classified as Commercial Real Estate (CRE) by RBI 6. Suggested additional risk weight of 25% since classified as CRE

RBI may soon do away with branch audit of PSU banks

Currently branches with advances of more than Rs 3 crore and above comes under branch auditors Branches with advances of more than Rs. 20 crore and above will have branch auditors Public Sector Banks will reduce substantial costs on auditor fees