The prudential norms are formulated on the basis of objective criteria rather than on any subjective consideration. This has brought in uniform and consistent application of the norms and greater transparency in published accounts of banks. The latest Master Circular No. DBOD.
No. BP.BC.9/21.04.048/2014-15 dated 1st July, 2014 issued by the RBI contains IRAC norms which are applicable for the statutory audit of banks for the year ending 31st March, 2015. For the first time, the RBI has introduced new frame work for revitalisation of distressed assets in the above circular. Audit of NPA would basically involve identification of an account as NPA, its correct classification, income recognition, provisioning, if an account is restructured and compliance of various conditions as enumerated in the Master Circular, etc.
1. Types of Assets
Standard Asset: An account is considered as standard asset when it is not non-performing and does not carry more than normal risk attached to the business.
Non-Performing Asset (NPA): An asset becomes NPA when it ceases to generate income for the bank. This would mean that an account would be classified as NPA on the basis of record of recovery rather than security charged in favour of the bank in respect of such account. Thus, an account would become NPA if interest charged to that particular borrower is not realised within the prescribed time frame despite the account being fully secured.
2. Identification of Account as NPA
The RBI has laid down under mentioned criteria for classification of various types of advances as NPA which is based on record of recovery:
(i) Term Loan: Interest and/or instalment of principal remain overdue for a period of more than 90 days. It is very important to note here that as per para 2.1.3 of the Master Circular, an account would be classified as NPA only if the interest due and charged during any quarter is not serviced fully within 90 days from the end of the quarter. For example, interest is charged on 30th November, 2014 in a term loan account. Now, if it is not serviced within 90 days from 31st December, 2014, then term loan account would become NPA, not otherwise.
(ii) Overdraft/Cash Credit: If an account remains out of order, it would become NPA. For this purpose, an account would be treated as ‘out of order’, if:
a. The outstanding balance remains continuously in excess of the sanctioned limit/drawing power for 90 days or more, or
b. Even if the outstanding balance in the account is less than the sanctioned limit/drawing power, there are no credits in the account continuously for 90 days as on the date of the balance sheet, or
c. Credits in the account are not sufficient to cover interest debited during the same period.
As on 31st March, 2015, if any of the above criteria is satisfied, the account would be classified as NPA. Auditor should verify stock statement to check the correctness of drawing power and whether the same is calculated in accordance with the approved policy of bank. Auditor should not assume sanctioned limit to be the drawing power. There may be instances where drawing power would be less than the sanctioned limit. For example, sanctioned limit of an account may be R25 lakh but the drawing power of the account may not necessarily be R25 lakh and it could less than that. A CC/OD account which is classified as standard may get classified as NPA because of an error in calculation of drawing power.
(iii) Bills Purchased/Discounted: If the bill purchased or discounted remains overdue for a period of more than 90 days from its due date.
(iv) Agricultural Advances: A loan granted for
a. Short duration crops will be treated as NPA, if the installment of principal or interest thereon remains overdue for two crop seasons.
b. Long duration crops will be treated as NPA, if the installment of principal or interest thereon remains overdue for one crop season.
For the purpose of these guidelines, “long duration” crops would be crops with crop season longer than one year and NPA date would depend on crop cycle, which is decided by State Level Bankers’ committee in each state.
(v) The amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of guidelines on securitisation dated 1st February, 2006.
(vi) 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.
(vii) A credit card account will be treated as NPA, if the minimum amount due, as mentioned in the statement, is not paid fully within 90 days from the next statement date. The gap between two statements should not be more than a month.
(viii) Guidelines for classification of projects under implementation are as under:
- Before commencement of commercial operation – Classify as NPA if interest/instalment is 90 days’ overdue.
- Failure to commence commercial operation within two years (IS)/one year (NIS) from DCCO – Classify as NPA even if it is regular as per record of recovery unless restructured and eligible to be classified as Standard.
- Restructuring due to court cases – a) Can be retained as Standard if restructured within two years from original DCCO. b) DCCO can be extended up to 4 years beyond the original DCCO.
- Restructuring due to other reasons – a) Can be retained as Standard, if restructured within two years from original DCCO. b) DCCO can be extended up to 3 years beyond the original DCCO.
NON INFRASTRUCTURE SECTOR
- Before commencement of commercial operation Classify as NPA if interest/instalment is overdue.
- Failure to commence commercial operation within two years (IS)/one year (NIS) from DCCO Classify as NPA even if it is regular as per record of recovery unless restructured and eligible to be classified as Standard.
- Restructuring due to court cases Not applicable
- Restructuring due to other reasons – a) Can be retained as Standard, if restructured within one year from original DCCO. b) DCCO can be extended up to another one year (beyond the existing extended period of 2 years, i.e., total extension of 3 years).
a) For all projects financed by the financial institutions (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.
b) ‘Project Loan’ would mean any term loan which has been extended for the purpose of setting up of an economic venture. Banks should fix a Date of Commencement of Commercial Operations (DCCO) for all project loans at the time of sanction of the loan/financial closure.
c) The above asset classification norms would apply to the project loans before commencement of commercial operations.
d) The above guidelines would not be applicable for restructuring of advances which are dealt with different sets of guidelines.
e) Any change in the repayment schedule of a project loan would not be treated as restructuring if :
(i) The increase in scope and size of the project takes place before commencement of commercial operations of the existing project.
(ii) The rise in cost excluding any cost-overrun in respect of the original project is 25% or more of the original outlay.
(iii) The bank re-assesses the viability of the project before approving the enhancement of scope and fixing a fresh DCCO.
(iv) On re-rating, (if already rated) the new rating is not below the previous rating by more than one notch.
3. Exceptions/ Clarifications
3.1 Accounts with temporary deficiencies:
An account should not be classified as NPA, if the deficiencies like non-submission of stock statement, non-renewal of facility in the account are temporary in nature, etc. RBI’s guidelines in this regard are as under:
a) Drawing power is required to be arrived at based on the current stock statement. However, considering the difficulties of large borrowers, stock statements relied upon by the banks for determining drawing power should not be older than three months. The outstanding balance in the account based on drawing power calculated from stock statements older than three months, would be deemed as irregular. A CC/OD account would become NPA if such irregular drawings are permitted in the account for a continuous period of 90 days. For example, if borrower is allowed drawing on the basis of stock statement of August 2014 for next three months, then it would be irregular from December 2014. If the borrower does not submit fresh stock statement then the account would become NPA in March 2015.
b) An account, where the regular/adhoc credit limits have not been reviewed/renewed within 180 days from the due date/date of adhoc sanction, will be treated as NPA.
3.2 Asset Classification to be borrower-wise and not facility-wise
All the facilities granted by a bank to a borrower and investment in all the securities issued by the borrower will have to be treated as NPA/NPI and not the particular facility/investment or part thereof which has become irregular. However, there are following exceptions to this guideline:
a) Under the on-lending system, only that particular credit facility granted to PACS/FSS which is in default will be classified as NPA and not all the credit facilities sanctioned to a PACS/FSS.
b) Any amount, representing positive mark-to-market value of the foreign exchange derivative contracts (other than forward contract and plain vanilla swaps and options) that were entered into during the period April 2007 to June 2008, which has already crystallised or might crystallise in future and is/becomes receivable from the client, even if overdue for a period of 90 days or more, will not make other funded facilities provided to the client, NPA on account of the principle of borrower-wise asset classification, though such receivable overdue for 90 days or more shall itself be classified as NPA, as per the extant IRAC norms.
c) In respect of additional facilities sanctioned under the rehabilitation package approved by BIFR, classification norms will become applicable after a period of one year from the date of disbursement, i.e., additional facility can be treated as standard upto one year from the date of disbursement.
3.3 Advances under consortium arrangements
Asset classification of accounts under consortium should be based on the record of recovery of the individual member banks 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 lead bank and the lead bank 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. If the bank is able to 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, they may be able to make proper classification in their books.
3.4 Advances against Term Deposits, NSCs and KVP/IVP, etc.
Advances against term deposits, NSCs eligible for surrender, IVPs, KVPs and life policies need not be treated as NPAs. Advances against gold ornaments, government securities and all other securities are not covered by this exemption.
3.5 Government guaranteed advances
The credit facilities backed by guarantee of the Central Government though overdue may be treated as NPA only when the government repudiates its guarantee when invoked.
3.6 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 classified as ‘standard’.
3.7 Accounts regularised near about the balance sheet date
An account which is generally irregular, where a solitary or a few credits are recorded before the balance sheet date, should be carefully checked. Where the account indicates inherent weakness on the basis of the data available, the account should be deemed as a NPA. In other genuine cases, the auditors must obtain satisfactory evidence about the manner of regularisation of the account to eliminate doubts on their performing status.
4.1 Income Recognition
i) As per Accounting Standard 9 on Revenue Recognition and as per the Master Circular of the RBI, income should be recognised when there is a reasonable certainty about its realisability. In respect of NPA, there is no reasonable certainty about realisability of interest, therefore it is booked as income only when it is actually realised. If bank follows policy of charging interest in NPA account then same should not be taken to income but to unrealised interest or interest suspense account. 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 accounts. For example: A borrower has taken loan of R1 lakh against term deposit of R1.25 lakh. Balance in the account as on 31st March, 2015 is R1.10 lakh. Even though account is over drawn, income would be recognised since valueof deposit is more than the balance outstanding.
ii) Income on standard advances is recognised on accrual basis except in case of income on Central Government guaranteed advances, which would have otherwise become NPA, income is recognised on realisation.
iii) 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.
iv) In project loans, any funding of interest in respect of NPAs, if recognised as income, should be fully provided for.
v) If the amount of interest dues is converted into equity or any other instrument, and income is recognised in consequence, full provision should be made for the amount of income so recognised. However, if the conversion of interest is into equity which is quoted, interest income can be recognised at market value of equity, as on the date of conversion, not exceeding the amount of interest converted to equity.
vi) The income in respect of unrealised interest which is converted into debentures or any other fixed maturity instrument should be recognised only on redemption of such instrument.
vii) Fees and commissions earned by the banks as a result of re-negotiations or re-scheduling of outstanding debts should be recognised on an accrual basis over the period of time covered by the re-negotiated or re-scheduled extension of credit.
4.2 Reversal of Income
i) If any advance, including bills purchased and discounted, becomes NPA as at the close of any year, entire interest accrued and credited to income account in the past periods, should be reversed or provided for if the same is not realised during the year under audit. This will apply to government guaranteed accounts also.
ii) In respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in the current period and should be reversed or provided for with respect to past periods, if uncollected.
iii) The ‘finance charge’ component of finance income [as defined in ‘AS 19–Leases’ issued by 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.
4.3 Appropriation of Recovery in NPAs
In case of any recovery in the NPA, the application of recovery towards interest/principal should be based on the agreement with the borrower. In the absence of a clear agreement, banks should adopt an accounting principle and exercise the right of appropriation of recoveries in a uniform and consistent manner. Thus, as per the consistent policy of the bank, recovery may be appropriated towards interest or principal.
5. Asset Classification
Having identified an account as NPA, it is further required to be classified into -
a) Sub-standard Assets
b) Doubtful Assets
c) Loss Assets
An account which is classified as NPA for the first time, is categorised as sub-standard for a period of less than or equal to twelve months from the date of advance becoming NPA. However in following