AUDIT OF ADVANCES WITH REFERENCE TO PRUDENTIAL NORMS IN BANK
BRANCH AUDIT FOR THE YEAR 2013-14
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By CA. Ajay Agrawal
The verification of advances is the most important area in the year end statutory audit of a branch of a bank. Though various aspects relating to advances are required to be verified, considering the limited time available to the branch auditors, verification of compliance of the prudential norms on income recognition, asset classification and provisioning pertaining to Advances (IRAC norms) is of utmost importance.
These IRAC norms are prescribed by RBI by way of Circulars issued from time to time. RBI compiles these circulars every year and issues a master circular which incorporates the provisions of all the circulars issued in respect of IRAC norms till date. The last such revision was made by RBI vide Master Circular on IRAC norms pertaining to Advances issued on 1.7.13. The aforesaid master circular is applicable for audit for the year 2013- 14. Since the last master circular issued on 2.7.12, there are many changes in the IRAC norms and therefore it is necessary to take note of these changes.
To my mind the best way to verify the compliance of IRAC norms is to refer the related provisions of the circular at the time of carrying out the audit. I may mention here that a Table of Contents is given in the circular. Therefore, at the time of carrying out the audit, the para and page number of the relevant provision can be easily find out.
The master circular has been divided into 3 Parts – Part A deals with all the provisions relating to IRAC norms except restructuring of Advances, Part B deals with provisions relating to Prudential guidelines on Restructuring of Advances and Part C deals with Prudential Norms on Income Recognition, Asset Classification, Provisions and Capital Adequacy relating to Agricultural Debt Waiver and Debt Relief Scheme,
2008.
In a nut sell, as per these norms the policy of income recognition should be based on record of recovery. Therefore, an account will become NPA if interest or installment of principal remains unrealized for a period of more than 90 days even though enough security is available in the account to cover the entire outstanding. Likewise, the classification of the advances has to be done in a such way which would ensure uniform and consistent application of the norms. Also, the provisioning should be made on the basis of the period for which the asset has remained non performing and the availability of security and the realisable value thereof.
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Non Performing Assets:
An advance for the bank is either Performing or Non Performing. Generally speaking, an advance becomes non performing when it ceases to generate income for the bank.
A non performing asset (NPA) is a loan or an advance where; i) In respect of Term Loan interest and/ or installment of principal remain overdue for a period of more than 90 days. 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. However, it becomes overdue from the next day.
Therefore, if monthly interest is charged in an Account on 30 becomes overdue on 1 st th April,2013, it
May,2013 and if it is not realised within 31 st
2013, the Account becomes NPA as per this provision.
July,
However, there is an overriding provision in para 2.1.3 of the master circular as per which an account becomes NPA only if interest due and charged during any quarter is not serviced fully within 90 days from the end of the quarter.
Therefore, in the given example, if the interest due on 30 realized by 30 th on 31 st July, 2013. th April, 2013 is not
September, 2013, then the account will become NPA and not
Here, it is important to note that if any moratorium is given for payment of interest or repayment of principal then it does not fall due during the moratorium period and therefore during this period it is not overdue also.
To carry out verification of term loans, let us take few examples:
Example for a Regular Term Loan Account:
An advance of Rs. 6,00,000/- was given on 1 repaid in 60 monthly installments of Rs. 10,000/- each after a moratorium of
6 months with the 1 st month. st June, 2013 which is to be
installment falling due on 31 st December, 2013. The rate of interest is 12 % per annum which is to be paid at the end of each
The amount outstanding in the account was Rs. 6,06,000/- as on 31 st March,
2014. To arrive at the overdue amount in this account, first the drawing power as on 31 st March, 2014 should be calculated. Considering that the 1 st installment of Rs. 10,000/- was to be paid on 31 st December, 2013, 4 installments were required to be paid by 31 st March, 2014 together with interest debited at the end of each month. Therefore, the drawing power in the account on the above date was Rs. 5,60,000/- and the overdue amount
Rs. 46,000/- which consists of 4 installments of Rs. 10,000/- each and interest of Rs. 6,000/-. This implies that the borrower paid interest debited at the end of each month except March, 2014 and did not pay any of the installments and hence the account became NPA on 31 st March, 2014.
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Schematic/EMI based Term Loan:
In a schematic term loan where the Equated Monthly Installment (EMI) includes interest, calculation of drawing power and the overdue amount in the aforesaid manner is not possible. In such cases, the loan account is required to be verified from the date of grant of the loan to ascertain the number of installments required to be paid by the Balance Sheet date and the number of installments actually paid by the borrower. If more than 3 installments are overdue, then the account becomes NPA. ii) In respect of an Overdraft/Cash Credit (OD/CC), if the account remains ‘out of order’ it will become NPA:
An account should be treated as 'out of order' if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. It may be noted that the circular does not provide any period for the account remaining out of order. Yet, to my mind this is an unintended omission and if the account remains continuously in excess of the sanction limit/ drawing power for a period of more than 90 days then it becomes NPA. There is another provision as per which 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 or credits are not enough to cover the interest debited during the same period, then the account should be treated as 'out of order'.
If the debits arising out of devolvement of letters of credit or invoked guarantees are parked in a separate account, then the balance outstanding in that account should also be treated as part of the borrower’s principal operating account from the date of these debits for the purpose of application of these prudential norms.
In ascertaining the operating limit, the drawing power is required to be calculated with reference to the monthly stock statement submitted by the borrower. In case of cash credit accounts, stock statements are generally not scrutinized by the branches and therefore, Drawing Power (DP) is not correctly calculated. Some of the deficiencies which can be found in the stock statements are: (a) Book Debts over 3/ 6 months is considered in calculation of DP as such figure is not disclosed in the Stock Statement though as per the sanction letter they are not to be considered for the purpose of calculation of
DP, (b) creditors for goods not deducted, (c) non moving stock not excluded
(d) Stock Statement not submitted in the prescribed format of the bank etc.
Due to the above reasons the DP is not correctly calculated and the borrower enjoys excess DP. Therefore, if there are such deficiencies in the stock statement, further verifications such as credit summation in the account, projected vs. actual turnover, continuous devolvement of LCs, if any etc. are required to be carried out. Furthermore, figures reported in the stock statement of the relevant date should also be cross verified (a) with the latest audited accounts available and (b) with the level of operating activity as per the CMA data and other periodic returns such as QIS submitted by the borrower. These verifications are important for ascertaining whether the account is performing or NPA.
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Example : The sanction limit in a cash credit account is Rs. 10,00,000/-. The loan was given on 1 st July, 2013 against stock with a margin of 25%. The borrower is required to submit monthly stock statement by 15 succeeding month. The borrower submitted stock statement for November,
13, the drawing power is calculated as follows: th of the
13 as per which the stock was Rs. 15,00,000/- and creditors for goods Rs.
3,00,000/-. On receipt of this stock statement let us say on 15 th December,
Particulars
Value of stock
Less: Creditors
Amount
(Rs.)
15,00,000
Value of paid stock
Less: Margin @ 25%
Drawing power
3,00,000
12,00,000
3,00,000
9,00,000
For simplicity sake, let us assume that the value of stock and creditors in each of the subsequent stock statements were the same.
The outstanding in the above account from 16 th December, 13 to 31 st March,
14 varied between Rs. 9,50,000/- to Rs. 9,90,000/- and the outstanding balance on 31 st March, 14 was Rs. 9,90,000/-. During the above period, the borrower deposited Rs. 1,00,000/- in the account and withdrew Rs. 60,000/-.
The interest debited between January, 14 to March, 14 amounted to Rs.
40,000/-. Up to December, 13 the borrower regularly paid the interest debited to the account.
From the facts of the above case, it may be seen that though the outstanding in the account was less than the sanction limit during the above mentioned period, it was always in excess of the drawing power during the period of more than 90 days as on the date of the balance sheet. Therefore, the account became NPA on 15 th March, 2014.
Modifying the above example, suppose the drawing power as per the stock statement during the above period was more than Rs. 10,00,000/- and the total credits in the accounts during the aforesaid period were Rs. 30,000/-.
Therefore, the account became NPA on 31 st March, 2014 as the credits in the account were not sufficient to cover the interest of Rs. 40,000/- debited between January,14 to March,14. Further, the unrealized interest of Rs.
10,000/- (Rs. 40,000/- minus Rs. 30,000/-) is required to be reversed. iii. One of the bills remains overdue for a period of more than 90 days in the case of bills purchased and discounted.
Example :
One bill for Rs. 1,00,000/- purchased on 1st October, 13 was due for payment after 90 days i.e on 31st December, 13 and remained unpaid till March, 2014.
The account became NPA on 31st March, 14 as the same was not paid for more than 90 days from the due date. Further, the interest income recognized in the account is required to be reversed.
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iv. The installment of principal or interest thereon remains overdue for two crop seasons for short duration crops. v. The installment of principal or interest thereon remains overdue for one crop season for long duration crops.
In case of agricultural advances, it is to be seen whether the advance is given for a short duration crop or a long duration crop. For this purpose, the crop season for each crop as determined by the State Level Bankers Committee in each State is to be referred to. In case of short duration crops where the installment of principal or interest thereon remains overdue for 2 crop seasons, then the account becomes NPA. In case of the long duration crops, if the installment or interest remains overdue for one crop season then the account is to be treated as NPA.
The above norms are applicable to all direct agricultural advances as listed in
Annexure 2 to the master circular. In respect of agricultural loans other than those specified in Annexure 2, identification of NPAs would be done on the same basis as non-agricultural advances i.e 90 days delinquency norms.
Example:
Loan for Short duration Crop: A crop loan was sanctioned/disbursed during May and June, 12 where the crop season ends in December, 12. The installment and interest of loan remained outstanding even after the end of 2 subsequent short duration crop seasons which ended in June and December
’13. In such a case, the account became NPA on 1 st
Loan for long duration crop:
January, 14.
Period of disbursement -- October, 11
Due date of repayment -- December, 12
Next crop season ended in -- December, 13
NPA on -- 1 st January, ’14.
In respect of agricultural advances as well as advances for other purposes granted by banks to Primary Agricultural Credit Societies(PACS) and Farmers’
Service Societies(FSS) under the on-lending system, only that particular credit facility granted to these societies which is in default for a period of two crop seasons in case of short duration crops and one crop season in case of long duration crops, as the case may be, after it becomes due will be classified as
NPA and not all the credit facilities sanctioned to these societies. Other direct loans & advances, if any, granted by the bank to the member borrower of these societies outside the on- lending arrangement will become NPA when any one of the credit facilities granted to the same borrower becomes NPA as per general delinquency norms. vi. The amount of liquidity facility remains outstanding for more than 90 days in respect of a securitization transaction undertaken in terms of guidelines on securitization dated February 1, 2006.
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vii. in respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment.
Income Recognition Policy
Internationally income from non performing assets (NPAs) is not recognised on accrual basis but is booked as income only when it is actually received.
Therefore, banks should not charge and take to income account interest on any NPA. It may be noted that this provision is not only in respect of interest but all other income such as fees, commission etc. charged by the bank.
However, interest on advances against term deposits, NSCs, IVPs, KVPs and
Life policies may be taken to income account on the due date provided adequate margin is available in the account irrespective of the fact whether there is any realization in these accounts or not. Further, irrespective of such non realization, such accounts remain standard i.e they do not become NPA.
However, advances against gold ornaments, government securities and any other security are not covered by this exemption.
This means wherever the outstanding in the account is less than the principal amount of security and the interest accrued thereon or the surrender value as the case may be, income in such a case can be recognized even though it is not actually received.
There are certain other provisions regarding Income Recognition which I will take up while dealing with the respective provision.
Reversal of income
If any advance, including bills purchased and discounted, becomes NPA, the entire interest accrued and credited to income account including fees, commission and similar income in the past periods, should be either reversed or transferred to interest suspense account, if the same is not realized. This will apply to Government guaranteed accounts also.
Therefore, when an account becomes NPA it is important to verify that the unrealized income has been reversed.
If the unrealized income in a NPA is converted into Funded Interest Term
Loan (FITL) or any security (debt/equity), a provision for an equal amount should be made simultaneously by crediting interest suspense account.
However, the market value of quoted equity shares received on conversion of the unrealized interest into investment in equity shares then in such case it may be booked as income to the extent of unrealized interest.
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Leased Assets:
The
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 non performing, and remaining unrealised, should be reversed or provided for in the current accounting period.
Appropriation of recovery in NPAs:
In case of any recovery in NPAs, the appropriation of recovery towards interest or principal should be based on agreement with the borrower. In the absence of agreement, banks should appropriate the recovery in an uniform and consistent manner.
Here, it is important to go through the accounting policy of banks in this respect. Generally, the accounting policy is as follows:
Therefore, based on the above accounting policy, except in case of suit filed and decreed accounts and compromise cases, any recovery made in NPAs is first appropriated towards interest and then towards principal.
Further, whenever any recovery is made in a NPA, the same is taken to income to the extent of unrecognized income 1 st against the amount lying in interest suspense account and then in respect of memoranda interest. This is subject to the provision that such credit is not out of fresh/additional credit facility granted to the borrower.
It is important to verify this as sometimes branches, in order to reduce the amount of NPAs, do not recognize income pursuant to recoveries made even though there is unrecognized interest as per memoranda record. This is done even though this adversely impacts the bottom line.
It is also important to understand what constitutes recovery. When an account becomes NPA, banks do not allow the borrower to withdraw any money deposited in the account. Therefore, the borrower stops operating the account. In order to avoid such a situation, banks allow the borrower to operate the account subject to the condition that a certain percentage of the amount deposited by the borrower say 10 to 15%, will be appropriated by the bank to regularize the overdue amount. This is called “tagging” in the banking parlance. Therefore, in such a case, only the amount appropriated by the bank i.e amount deposited by the borrower net of withdrawals is the actual recovery in the account and not the total amount deposited in the account.
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ASSET CLASSIFICATION & PROVISIONING
Categories of NPAs:
Banks are required to classify non performing assets further into the following three categories based on (a) the period for which the asset has remained non performing and (b) the realisable value of available security: i. ii iii.
Sub Standard Assets
Doubtful Assets
Loss Assets.
Sub Standard Assets: i) A sub standard asset is one which has remained NPA for a period of less than or equal to 12 months. ii)
It is, however, important to note that the period of 12 months for an account which became NPA say on 31 st March, 2013 will be over on
30 th March, 2014. Therefore, on 31 date. st March, 2014 the account cannot be termed as sub-standard – it will become a doubtful asset on that
The provisioning requirement for sub standard assets is 15% of the total outstanding in all the accounts of the borrower without making any allowance for ECGC cover and security available. An additional provision of 10% is required to be made in respect of “Unsecured
Exposure” which, for the purpose of this provisioning, means an account where the realizable value of security
is not more than 10 % of the outstanding exposure which includes all funded and non-funded exposures. Therefore, the total provisioning in such sub standard accounts is 25%. However, if such sub standard account is for an infrastructure project, then the total provision requirement is
20%.
For the above purpose, security means tangible security properly charged to the bank and does not include intangible securities like guarantees, comfort letter etc. Example of loans with unsecured exposure are borrowers undertaking Infrastructure Projects such as
Roads, Bridges etc. on BOT basis where the asset is owned by the government and not by the borrower.
In the following circumstances, the NPA should be straightaway classified as doubtful/loss asset from the date when it becomes NPA without 1 st classifying it as sub standard:
(a) If the present realisable value of security is less than 50% of the value assessed by the bank or accepted by RBI at the time of inspection, or
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i)
(c) There is potential threat to recovery due to erosion in security value or non availability of security and existence of other factors such as fraud committed by the borrower.
Doubtful Assets:
A doubtful asset is a NPA which remained in sub standard category for a period of 12 months i.e after the end of 12 months the account deteriorates from sub standard category to doubtful category. ii)
(b) If the realisable value of security is less than 10% of the outstanding advance provided the advance was not unsecured ab-initio, or
In case of a doubtful asset, the provisioning requirement is cent percent to the extent to which the advance is not covered by realizable value of security to which the bank has valid recourse i.e the unsecured portion.
As regards the secured portion, the provision ranges from 25% to
100% depending upon the period for which the advance has remained doubtful:
Period for which the advance has remained in doubtful category
Up to 1 year (D1)
1 – 3 years (D2)
Provision requirement
( %)
25
40
More than 3 years (D3) 100 iii) It is important to note here that the secured portion is calculated with reference to the realizable value of security and not the market value thereof. The realizable value means the value which the bank may realize from selling the security. As the bank is treated as distress seller, the realizable value is generally 15 to 20% less than the market value of the security. Further, this value has to be ascertained as on the date of the balance sheet. Therefore, in case of NPAs, to ascertain the realisable value of security such as immovable property, the branch is required to obtain valuation report once in a period of 3 years from one of its empanelled Valuers. As the provision in the account is based on such valuation report, it is important to verify the following with regard to the valuation report:
(a) Whether the valuer is competent to make the valuation - a mechanical engineer should not be considered to be competent to value a real estate property?
(b) Whether the valuation report has been given in the format prescribed by the bank for the purpose?
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(c) Whether the valuer has made necessary allowance from the market value of the property to arrive at the distress sale value which is the realizable value for the bank?.
(iv) In case of valuation of depreciable assets such as plant and machinery etc., it should be ensured that suitable depreciation has been deducted from the value of property if the valuation report is more than 1 year old.
(v) In case of NPAs with outstanding balance of Rs. 5 crore and above, stock audit at annual intervals is required to be carried out by external agencies to verify the reliability of the stock statement submitted by the borrower.
Loss Assets:
A loss asset is one where the outstanding is considered as uncollectable although there may be some salvage or recovery value of the security. Generally, where the salvage /realizable value of security is less than 10% of the outstanding balance then the asset is to be considered as loss asset.
Such loss asset is either required to be written off or fully provided for.
Identification of NPAs:
It may be mentioned here that as per the requirement of Reserve Bank of
India, banks have now started identifying NPAs through the system which can identify an account where say the interest and / or installment has not been paid for more than 90 days. It may be seen that such identification by the system is based on certain basic data fed in the borrower’s account by the bank staff e.g. (a) amount and periodicity of payment of installment which is part of the ‘master creation’ for the borrower’s account in the system, (b) drawing power which is based on monthly stock statement etc.
It may be mentioned here that due to incorrect data or due to deficiency in the software, the system identified NPA may be incorrect in some cases.
Therefore, these cases may be verified with reference to the terms of sanction. It is also possible that due to a mistake in master creation, some accounts have been omitted to be identified as NPA.
However, it may be noted that in many banks, the aforesaid identification is only informative i.e the system neither makes an account NPA on its own nor a report of such system identified NPAs can be generated and therefore the bank officials are required to manually classify the concerned account as NPA.
A case in point is forensic audit carried out in a bank recently where it was found that the flag for marking an account as NPA was not operative.
However, the system does provide SMA-1 and SMA-2 statements. This is a monitoring tool for the banks. SMA means ‘Special Mention Account ‘ – the
SMA-1 statement contains names of the borrower accounts where interest
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and/or installment in a term loan account is overdue for 1 month or a cash credit account is irregular for 1 month etc. The SMA-2 statement provides the names of those borrower accounts where such over dues/irregularity are continuing for 2 months or more.
Therefore, we should obtain the SMA-1 and SMA-2 statements from the branch and verify these borrower accounts to find out the deficiencies in these accounts as also identify those accounts where the over dues/irregularity is continuing for 3 months or more. In some banks, this statement is called
Special Watch Accounts or Potential NPA Accounts.
I may mention here that RBI has recently formulated a “Framework for
Revitalising Distress Assets in the Economy” for “Early recognition of Financial distress, Prompt Steps for Resolution and Fair Recovery for lenders” which is applicable from 1 st April, 2014. Among other things, as per the Framework, a new sub category called SMA-0 has been created which will include advances where principal or interest payment is not overdue for more than 30 days but the account shows signs of stress. The Framework identifies 8 such signs one of which is return of 3 or more cheques issued by the borrower in 30 days due to non availability of balance or DP in the account. The banks are required to update their system so that it can catch these early warning signals and identify SMA-0 accounts and provide MIS at individual account level as well as segment level.
Banks are also required to have system generated segment wise information on non-performing and restructured assets which may include data on the opening balances, additions, reductions (up gradations, actual recoveries, write offs etc.), closing balances, provisions held, technical write offs etc.
We should also go through the previous year’s LFAR, internal inspection report of the bank, RBI inspection report etc. and take note of the various deficiencies pointed out therein and accordingly verify those borrower accounts and check whether they have become NPA as on the balance sheet date.
We should also verify the borrower’s loan ledgers and take note of the conduct of the account such as credit summation in the account, payment of interest and installments etc. The credit summation should be crossed verified with the turnover to see whether the borrower is depositing the entire sale proceeds in the account.
The book debt statement prepared by the branches for the purpose of year end closing should also be verified. These statements contain detailed information regarding all the borrower accounts such as the outstanding balance, nature of loan, sanction limit, drawing power, date of last payment of interest and installment, value of security, the asset classification i.e Standard or sub standard or doubtful etc.
By scrutiny of this statement, the accounts where apparently there are over dues/irregularity can be identified based on which further verification of these loan accounts can be done – e g. say (a) in a cash credit account, the outstanding balance is more than the sanction limit/drawing power by 5%. In
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such case, on verification of the account of the borrower, it may reveal that such outstanding over sanction limit/drawing power is due to non payment of interest for more than 90 days and (b) in case of a term loan which was sanctioned say 2 years back and the outstanding balance is almost the same as the sanction limit. In such a case, on verification of the repayment schedule, it may be found that the borrower has not paid a number of installments and the account is actually NPA though classified as standard by the bank. Like wise useful information can be obtained in respect of other accounts also.
Availability of security / net worth of borrower/ guarantor:
The availability of security or net worth of borrower/ guarantor should not be taken into account for the purpose of treating an advance as NPA or otherwise, as income recognition is based on record of recovery.
Accounts with temporary deficiencies:
As discussed above, the classification of an asset as NPA should be based on the record of recovery. However, there are certain other deficiencies also due to which an account becomes NPA These are: a) In a cash credit account, the drawing power is calculated based on the latest stock statement. However, sometimes there is delay on part of the borrower to submit the stock statement. As per the norms, if the stock statement is not submitted for more than 3 months, the drawing power is to be considered as Nil. If the borrower does not submit the stock statement for a further period of 90 days, the account becomes NPA even though the unit may be working or the borrower’s financial position may be satisfactory.
Example:
The last stock statement submitted by the borrower is for September,
13. After this, the borrower has not submitted any stock statement. In such a case, on 31st December, 13 the aforesaid stock statement became older than 3 months and hence the drawing power became
Nil on that date. As the borrower did not submit any stock statement till 31st March, 2014, the account becomes NPA on 31 st March, 2014. b) The limits are required to be reviewed and renewed within a period of
3 months from the due date. For the purpose of renewal, the banks ask the borrower to submit latest audited accounts and other relevant information. In case the borrower does not submit the required papers, the bank is unable to review/ renew the account. In such a case, if there is delay of 180 days from the due date, the account becomes NPA.
The renewal is to be done by preparing a prescribed Review/ Renewal note based on the required financial data submitted by the borrower.
When such regular review/renewal procedure could not be complied with, towards the year end, with a view to avoid the account
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becoming NPA, branches resort to short review which is sometimes done in a very sketchy manner. However, as this is not an approved way of carrying out a review/ renewal procedure prescribed under the relevant instructions of the bank, it should not be accepted as a review/renewal and the account should be treated as NPA.
(c) If any ad hoc limit has been given to a borrower and the same is either not paid or converted into a regular limit within 180 days from the date of sanction of the ad hoc limit, the account becomes NPA.
Accounts regularized near the Balance Sheet Date:
Where there is inherent weakness in an account, even if due to a solitary or few credits before the balance sheet date the overdue amount is recovered or the irregularity is regularized as the case may be, the account should still be treated as NPA unless the bank can give satisfactory evidence otherwise.
Up gradation of loan accounts classified as NPAs:
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 upgraded to ‘standard’ - category.
It may be mentioned here that the borrower accounts which are classified as
NPA by the statutory auditors or RBI are latter on upgraded by the bank even though the irregularity has not been fully regularized or the overdue amount has not been fully recovered. Therefore, we should take note of the NPAs as per previous year’s book debt statement and MOC and see whether they are still classified as NPA. If not, we should go through the account of the borrower and other related papers and verify whether the upgradation has been correctly done.
With regard to up gradation of a restructured/ rescheduled account provisions of Part B of this circular are applicable. I will deal with those provisions of after a while.
Asset Classification to be borrower-wise and not facility-wise:
It is difficult to envisage a situation when only one facility to a borrower becomes a problem credit. Therefore, all the facilities granted by a bank to a borrower will have to be treated as NPA and not the particular facility or part thereof which has become irregular.
Advances under consortium arrangements
The Asset classification of accounts under consortium should be based on record of recovery of the individual member bank and other aspects having a bearing on the recoverability of the advances. Where the remittances by the borrower under consortium lending arrangements are pooled with one bank and/or where the bank receiving remittances is not parting with the share of other member banks, the account will be treated as not serviced in the books of the other member banks and therefore, be treated as NPA. The banks
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participating in the consortium should, therefore, arrange to get their share of recovery transferred from the lead bank or get an express consent from the lead bank for the transfer of their share of recovery, to ensure proper asset classification in their respective books.
Government guaranteed Advances:
Where a credit facility is backed by guarantee of Central Government, such facilities even though overdue for a period of more than 90 days will become
NPA only when the Government repudiates its guarantee when invoked.
However, this exemption from classification of an advance as NPA is not for the purpose of recognition of income which in such cases is to be recognised on cash basis. Further, this exemption is also not available in respect of advances guaranteed by State Governments.
Project under implementation:
Where commencement of a project is delayed beyond the specified period, it is classified as NPA. In this respect various dates of sanction of loan have been given in the master circular based on which the relevant provisions are applicable.
In respect of Projects under implementation after 28.05.02 and financial closure formally documented: If period of delay from the date of completion as originally envisaged is more than 2 years (w.e.f. 31.03.08) for Infra projects or 6 months for other projects, the account will be treated as NPA even if the borrower is regular in payment of interest and installment.
Post-shipment Supplier's Credit:
In respect of post-shipment credit extended by banks covering export of goods to countries for which ECGC cover is available, EXIM Bank has introduced a guarantee-cum-refinance programme whereby, in the event of default, EXIM Bank will pay the guaranteed amount to the bank within a period of 30 days from the day the bank invokes the guarantee after the exporter has filed claim with ECGC.
Accordingly, to the extent payment has been received from EXIM Bank, the advance may not be treated as a non performing asset for asset classification and provisioning purposes.
In the case of advances classified as doubtful and guaranteed by ECGC, provision should be made only for the balance amount which is not covered by the guarantee of the Corporation. Further, while arriving at the provision required to be made for doubtful assets, realisable value of security should first be deducted from the outstanding balance and then provision be made as illustrated hereunder:
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Example
Outstanding Balance
ECGC Cover
Period for which the advance has remained doubtful
Value of security held (excludes worth of Rs.)
Rs. 4 lakhs
60 percent
More than 2 years remained doubtful
(say as on March 31,2014)
Rs. 1.50 lakhs
Provision required to be made
Outstanding balance
Less: Value of security held
Unrealizable balance
Less: ECGC Cover (60% of unrealizable balance)
Net unsecured balance
Provision for unsecured portion of advance
Provision for secured portion of advance (as on March 31, 2014)
Total provision to be made
Rs. 4.00 lakhs
Rs. 1.50 lakhs
Rs. 2.50 lakhs
Rs. 1.50 lakhs
Rs. 1.00 lakhs
Rs. 1.00 lakhs @ 100 percent of unsecured portion
Rs. 0.60 lakhs @ 40 per cent of the secured portion
Rs. 1.60 lakhs (as on March 31,2014)
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PRUDENTIAL GUIDELINES ON RESTRUCTURING OF ADVANCES BY BANKS –
PART B OF THE MASTER CIRCULAR
(In this part the para numbers of the master circular have been given for the purpose of referring to the relevant provisions)
I may mention at the outset that restructuring is being done by banks in all type of accounts whether large or small. Therefore, restructured accounts will be found in most of the branches.
It may be noted that while the general principles laid down in para 11 inter-alia stipulate that 'standard' advances should be re-classified as 'sub-standard' immediately on restructuring, all borrowers, with the exception of the borrower categories specified in para 14.1 of this part of the circular, will be entitled to retain the asset classification upon restructuring, subject to the conditions enumerated in para 14.2 of this part of the circular.
11. General Principles and Prudential Norms for Restructured Advances
The principles and prudential norms laid down in this paragraph are applicable to all advances including the borrowers who are eligible for special regulatory treatment for asset classification as specified in para 14. In these cases, the provisions of para 11.1.2, 11.2.1 and 11.2.2 would stand modified by the provisions in para 14.
11.1 Eligibility criteria for restructuring of advances
11.1.1 Banks may restructure the accounts classified under 'standard', 'sub standard' and 'doubtful' categories.
11.1.2 Banks can not reschedule / restructure / renegotiate borrower accounts with retrospective effect. While a restructuring proposal is under consideration, the usual asset classification norms would continue to apply. The process of re classification of an asset will not stop during the period when the restructuring proposal is under consideration. The asset classification status as on the date of approval of the restructured package by the competent authority is relevant to decide the asset classification status of the account after restructuring / rescheduling / renegotiation. However, these provisions will not be applicable if the borrower account is eligible for special regulatory treatment in which case the provisions of para 14.2.1 will be applicable.
11.1.4 No account will be taken up for restructuring by the banks unless the financial viability is established and there is a reasonable certainty of repayment by the borrower, as per the terms of restructuring package. The viability should be determined based on acceptable viability benchmarks such as DSCR, ROCE etc. The accounts not considered viable should not be restructured. Any restructuring done without looking into cash flows of the borrower and assessing the viability would be treated as an attempt at ever greening a weak credit facility.
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I may mention here that often there are accounts which have been restructured without assessing the viability.
11.1.6 BIFR cases are not eligible for restructuring without their express approval.
11.2 Asset classification norms
Restructuring of advances could take place in the following stages:
(a) before commencement of commercial production / operation;
(b) after commencement of commercial production / operation but before
the asset has been classified as 'sub-standard'; c) after commencement of commercial production / operation and the asset
has been classified as 'sub-standard' or 'doubtful'.
11.2.1 The accounts classified as 'standard assets' should be immediately reclassified as 'sub-standard assets' upon restructuring. However, this provision is not applicable if the borrower account is eligible for special regulatory treatment.
11.2.2 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 the asset classification norms with reference to the pre-restructuring repayment schedule. However, this provision is not applicable if the borrower account is eligible for special regulatory treatment.
11.2.3 All restructured accounts which have been classified as non-performing assets upon restructuring, would be eligible for up-gradation to the 'standard' category after observation of 'satisfactory performance' during the 'specified period'.
Specified Period:
Specified period means a period of one year from the date when the first payment of interest or installment of principal falls due under the terms of restructuring package.
Satisfactory Performance:
Satisfactory performance during the specified period means adherence to the following conditions during that period:
Non-Agricultural Cash Credit Accounts:
In the case of non-agricultural cash credit accounts, the account should not be out of order any time during the specified period, for a duration of more than 90 days. In addition, there should not be any irregularity at the end of the specified period.
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Non-Agricultural Term Loan Accounts:
In the case of non-agricultural term loan accounts, no payment should remain overdue for a period of more than 90 days. In addition, there should not be any overdue amount at the end of the specified period.
All Agricultural Accounts:
In the case of agricultural accounts, at the end of the specified period, the account should be regular.
11.2.4 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 prerestructuring payment schedule.
11.2.5 Any additional finance may be treated as 'standard asset' up to a period of one year after the first interest / principal repayment, whichever is earlier, falls due under the approved restructuring package. However, in the case of accounts where the pre restructuring facilities were classified as 'substandard' 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.
11.2.6 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
Sub standard. 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.
11.3 Income recognition norms:
Interest income in respect of restructured accounts classified as 'standard assets' will be recognized on accrual basis and that in respect of the accounts classified as 'non-performing assets' will be recognized on cash basis.
14. Special Regulatory Treatment for Asset Classification:
14.1 The special regulatory treatment for asset classification, in modification to the provisions in this regard stipulated in para 11, will be available to the borrowers engaged in important business activities, subject to compliance with certain conditions as enumerated in para 14.2 below. Such treatment is not extended to the following categories of advances:
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i. Consumer and personal advances, ii. Advances classified as Capital market exposures, iii. Advances classified as commercial real estate exposures.
The asset classification of these three categories of accounts as well as that of other accounts which do not comply with the conditions enumerated in para 14.2, will be governed by the prudential norms in this regard described in para 11 above.
14.2 Elements of special regulatory framework:
The special regulatory treatment has the following two components: i) Incentive for quick implementation of the restructuring package,
(ii) Retention of the asset classification of the restructured account in the
pre-restructuring asset classification category.
14.2.1 Incentive for quick implementation of the restructuring package:
As stated in para 11.1.2, during the pendency of the application for restructuring of the advance with the bank, the usual asset classification norms would continue to apply. The process of reclassification of an asset will not stop merely because the application is under consideration. However, as an incentive for quick implementation of the package, if the approved package is implemented by the bank as per the following time schedule, the asset classification status may be restored to the position which existed when reference was made to the CDR cell in respect of cases covered under the
CDR Mechanism or when the restructuring application was received by the bank in non-CDR cases:
(i) Within 120 days from the date of approval under the CDR Mechanism,
(ii) Within 90 days from the date of receipt of application by the bank in
cases other than those restructured under the CDR Mechanism.
14.2.2 Asset classification benefits
Subject to the compliance with the undernoted conditions in addition to the adherence to the prudential framework laid down in para 11, the following benefits will be available to a restructured account:
(i) In modification to para 11.2.1, an existing 'standard asset' will not be downgraded to the sub-standard category upon restructuring:
(ii) In modification to para 11.2.2, during the specified period, the asset classification of the sub-standard / doubtful accounts will not deteriorate upon restructuring, if satisfactory performance is demonstrated during the specified period.
However, these benefits will be available subject to compliance with the following conditions:
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i) The dues to the bank are 'fully secured' as defined in Annex - 5. The condition of being fully secured by tangible security will not be applicable in the following cases:
(a) MSE borrowers, where the outstanding is up to Rs.25 lakh,
(b) Infrastructure projects, provided the cash flows generated from these projects are adequate for repayment of the advance, the financing bank(s) have in place an appropriate mechanism to escrow the cash flows, and also have a clear and legal first claim on these cash flows.
(c) Dues of Micro Finance Institutions (MFIs) restructured up to March
31, 2011. ii) The unit becomes viable in 8 years (earlier 10 years), if it is engaged in infrastructure activities, and in 5 years (earlier 7 years) in the case of other units. iii) Promoters' sacrifice and additional funds brought by them should be a minimum of 20% of banks' sacrifice or 2% of the restructured debt whichever is higher (earlier 15%). iv) The restructuring under consideration is not a 'repeated restructuring as defined in para (v) of Annex - 5.
I may mention here that there are many accounts which do not comply with some of the above conditions and are therefore not entitled to the special regulatory treatment.
Repeatedly Restructured Accounts
When a bank restructures an account a second or more time, the account will be considered as a 'repeatedly restructured account'. However, if the second restructuring takes place after the period upto which the concessions were extended under the terms of the first restructuring, that account shall not be reckoned as a
'repeatedly restructured account'.
If a project loan classified as ‘standard asset’ is restructured any time during the period up to two years from the original date of commencement of commercial operations (DCCO), it can be retained as a standard asset if the fresh DCCO is fixed within the following limits, and further provided the account continues to be serviced as per the restructured terms.
(a) Infrastructure Projects involving court cases
Up to another 2 years (beyond the existing extended period of 2 years as prescribed in para 4.2.15.3 i.e. total extension of 4 years), in case the reason for extension of date of commencement of production is arbitration proceedings or a court case.
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Infrastructure Projects delayed for other reasons beyond the control of promoters up to another 1 year (beyond the existing extended period of 2 years i.e. total extension of 3 years), in other than court cases.
In cases where there is moratorium for payment of interest, banks should not book income on accrual basis beyond two years from the original DCCO, considering the high risk involved in such restructured accounts.
In case of non –infrastructure projects, if the delay in commencement of commercial operations extends beyond the period of one year from the date of completion as determined at the time of financial closure, banks can prescribe a fresh DCCO, and retain the “standard” classification by undertaking the restructuring of accounts in accordance with the provisions contained in this Master Circular, provided the fresh
DCCO does not extend beyond a period of twelve months from the original DCCO.
This would among others also imply that the restructuring application is received before the expiry of six months from the original DCCO, and when the account is still
“standard” as per the record of recovery.
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