Income Recognition, Asset Classification (IRAC) and Provisioning Norms

In line with international practices and as per the recommendations made by the Committee on the Financial System (Chairman Shri M. Narasimham), the Reserve Bank of India has introduced, in a phased manner, prudential norms for income recognition, asset classification and provisioning for the advances portfolio of the banks to move towards greater consistency and transparency in the published accounts.

The policy of income recognition should be objective and based on a record of recovery rather than on any subjective considerations. Likewise, the classification of assets of banks has to be done based on objective criteria which would ensure a uniform and consistent application of the norms. Also, the provisioning should be made based on the classification of assets based on the period for which the asset has remained non­-performing and the availability of security and the realisable value thereof.

RBI issued Master Circular No. RBI/2023-24/06 Dated April 1, 2023 on Prudential norms on Income Recognition, Asset Classification, and Provisioning about Advances. Banks are urged to ensure that while granting loans and advances, realistic repayment schedules may be fixed based on cash flows with borrowers. 

PRUDENTIAL NORMS

The policy of income recognition should be objective and based on the record of recovery rather than on any subjective considerations. Likewise, the classification of assets of banks has to be done based on objective criteria which would ensure a uniform and consistent application of the norms. Also, the provisioning should be made based on the classification of assets based on the period for which the asset has remained non-performing and the availability of security and the realisable value thereof.

Banks are urged to ensure that while granting loans and advances, realistic repayment schedules may be fixed based on cash flows with borrowers. This would go a long way to facilitate prompt repayment by the borrowers and thus improve the record of recovery in advances.

Automation of IRAC Norms and Provisioning processes in banks

Banks were advised to have appropriate IT systems in place for the identification of Non-Performing Assets (NPA) and the generation of related data/returns, both for regulatory reporting and the bank’s own MIS requirements. It was observed that the processes for NPA identification, income recognition, provisioning, and generation of related returns in many banks are not yet fully automated. Now RBI issued circular Ref. No. DoS.CO.PPG./SEC.03/11.01.005/2020-21 Dated September 14, 2020 on Automation of Income Recognition, Asset Classification, and Provisioning processes in banks.

To ensure the completeness and integrity of the automated Asset Classification (classification of advances/investments as NPA/NPI and their up-gradation), Provisioning calculation, and Income Recognition processes, banks are advised to put in place / upgrade their systems to conform to the following guidelines latest by June 30, 2021. As per the norms coverage of accounts are as under.

• All borrowed accounts, including temporary overdrafts, irrespective of size, sector, or types of limits, shall be covered in the automated IT-based system (System) for asset classification, upgradation, and provisioning processes. Banks’ investments shall also be covered under the System.
• Asset classification rules shall be configured in the System, in compliance with the regulatory stipulations.
• Calculation of provisioning requirements shall also be System-based as per pre-set rules for various categories of assets, value of security as captured in the System, and any other regulatory stipulations issued from time to time on provisioning requirements.
• In addition, income recognition/derecognition in case of impaired assets (NPAs/NPIs) shall be system-driven, and the amount required to be reversed from the income account should be obtained from the System without any manual intervention.
• The System shall handle both the downgrade and upgrade of accounts through Straight Through Process (STP) without manual intervention.
• Frequency: The System-based asset classification shall be an ongoing exercise for both down-gradation and up-gradation of accounts. Banks should ensure that the asset classification status is updated as part of the end process.

NON-PERFORMING ASSETS

An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank. A non-performing asset (NPA) is a loan or an advance where;

1. Loan Account: For loan account, if the Interest and/or installment of principal remain ‘overdue’ for more than 90 Days.

Overdue status: 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.

2. Cash Credit or Overdraft Account: The account remains ‘out of order’ for more than 90 days.

Out of order status: Either the outstanding balance remains continuously more than the sanctioned limit/drawing power or 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.  

3. The Limit is not reviewed within 180 days from the due date of renewal.
4. Where stock statement has not been received for 90 days or more in case of Cash Credit Accounts.
5. Bills- The bill remains overdue for a period of more than 90 days from the due date of payment.
6. For Direct Agricultural loans: For short duration crops the Interest or instalment remaining overdue for 2 crop seasons & for long duration crop the Interest or instalment remaining overdue for 1 crop season.
7. The credit facilities backed by the Guarantee of Central Govt. though overdue, may be treated as NPA only when the Govt. repudiates its guarantee when revoked.
8. The credit facilities backed by the Guarantee of State Govt. become NPA normally.
9. In the case of bank finance given for industrial projects, housing loan or for agricultural plantations etc. where moratorium is available for payment of interest, payment of interest becomes ‘due’ only after the moratorium or gestation period is over.

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.

Projects under implementation: For all projects financed by the FIs/ banks , the ‘Date of Completion’ and the ‘Date of Commencement of Commercial Operations’ (DCCO), of the project should be clearly spelt out at the time of financial closure of the project and the same should be formally documented. These should also be documented in the appraisal note by the bank during sanction of the loan.

There are occasions when the completion of projects is delayed for legal and other extraneous reasons like delays in Government approvals etc. All these factors, which are beyond the control of the promoters, may lead to delay in project implementation and involve restructuring / reschedulement of loans by banks. Accordingly, the following asset classification norms would apply to the project loans before commencement of commercial operations.

For this purpose, all project loans have been divided into the following two categories:

1. Project Loans for infrastructure sector
2. Project Loans for non-infrastructure sector

For the purpose of these guidelines, ‘Project Loan’ would mean any term loan which has been extended for the purpose of setting up of an economic venture. Further, Infrastructure Sector is a sector as defined in extant Harmonised Master List of Infrastructure of RBI.

Classification of the loan against Term Deposits, NSCs, KVPs/IVPs, etc.: Advances against term deposits, NSCs eligible for surrender, IVPs, KVPs and life policies need not be treated as NPAs, provided adequate margin is available in the accounts. Advances against gold ornaments, government securities and all other securities are not covered by this exemption.

Classification will be done borrower-wise & not facility-wise: when only one facility to a borrower/one investment in any of the securities issued by the borrower becomes a problem credit/investment and not others. Therefore, 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.

In case of loans to PACS/FSS classification will be done facility-wise: In respect of advances granted by banks to PACS/ FSS 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.

Reversal of Income: 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 advances also.

In respect of NPAs, fees, commissions, 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 the income account before the asset became nonperforming, and remaining Unrealised, should be reversed or provided for in the current accounting period.

Upgradation 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’ accounts.

Appropriation of recovery in NPAs: Interest realised on NPAs may be taken to income account provided the credits in the accounts towards interest are not out of fresh/ additional credit facilities sanctioned to the borrower concerned.

In the absence of a clear agreement between the bank and the borrower for the purpose of appropriation of recoveries in NPAs (i.e. towards principal or interest due), banks should adopt an accounting principle and exercise the right of appropriation of recoveries in a uniform and consistent manner.

Interest Application: On an account turning NPA, banks should reverse the interest already charged and not collected by debiting Profit and Loss account, and stop further application of interest. However, banks may continue to record such accrued interest in a Memorandum account in their books. For the purpose of computing Gross Advances, interest recorded in the Memorandum account should not be taken into account.

COMPUTATION OF NPA LEVELS

Banks are advised to compute their Gross Advances, Net Advances, Gross NPAs and Net NPAs, as per the format given below.

• Gross Advances = Standard Asset Plus Gross NPA
• Gross NPAs as a percentage of Gross Advances = Gross NPA/Gross Advances
• Net Advances = Gross Advances – Deductions
• Deductions includes:

1. Provisions held in the case of NPA Accounts
2. DICGC / ECGC claims received and held pending adjustment
3. Part payment received and kept in Suspense Account or any other similar account
4. Balance in Sundries Account (Interest Capitalization – Restructured Accounts),
5. Floating Provisions
6. Provisions in lieu of diminution in the fair value of restructured accounts classified as NPAs
7. Provisions in lieu of diminution in the fair value of restructured accounts classified as standard assets

• Net NPAs = Gross NPAs minus Deductions (listed above)
• Net NPAs as percentage of Net Advances = Net NPAs/ Net Advances (in %)

Upgradation 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 nonperforming and may be classified as ‘standard’ accounts.

Early Recognition of Stress: Before a loan account turns into a NPA, banks are required to identify incipient stress in the account by creating three sub-categories under the Special Mention Account (SMA) category as given in the table below:

SMA Sub-categories	Basis for classification
SMA-0	Principal or interest payment not overdue for more than 30 days but account showing signs of incipient stress.
SMA-1	Principal or interest payment overdue between 31-60 days.
SMA-2	Principal or interest payment overdue between 61-90 days.

 

ASSET CLASSIFICATION

Banks are required to classify non-performing assets further into the following three categories based on the period for which the asset has remained nonperforming and the realisability of the dues:

1. Substandard Assets
2. Doubtful Assets
3. Loss Assets

Sub-Standard Assets – Account which has remained in NPA category for not more than 12 months. As to realisability these accounts show credit weakness and there is a distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful Assets – Account that remained in the NPA category for more than 12 months. A loan classified as Doubtful has all the weaknesses inherent to Sub-Standard assets with the added characteristic that the full recovery of the advance is highly improbable due to erosion of security value or fraud or such other reasons.

Loss Assets – Account where Loss has been identified by the bank or Internal Auditors or External Auditors or by RBI Inspector but the amount has not been written off. It is an asset that is considered uncollectible although there may be some salvage or recovery value.

Accounts where there is erosion in the value of security/frauds committed by borrowers: In respect of accounts where there are potential threats for recovery on account of erosion in the value of security or non­-availability of security and existence of other factors such as frauds committed by borrowers it will not be prudent that such accounts should go through various stages of asset classification. In cases of such serious credit impairment the asset should be straightaway classified as doubtful or loss asset as appropriate:

1. Erosion in the value of security can be reckoned as significant when the realisable value of the security is less than 50 percent of the value assessed by the bank or accepted by RBI at the time of the last inspection, as the case may be. Such NPAs may be straightaway classified under doubtful category and provisioning should be made as applicable to doubtful assets.
2. If the realisable value of the security, as assessed by the bank/ approved valuers/ RBI is less than 10 percent of the outstanding in the borrowal accounts, the existence of security should be ignored and the asset should be straightaway classified as loss asset. It may be either written off or fully provided for by the bank.

DETERMINATION OF ASSET CLASSIFICATION AND HEALTH CODE

 

To Determine the correct Asset Classification of an NPA borrower two aspects are Important:

1. “NPA Since” Date and,
2. “Value of Security”

Note– When RVS (Both Primary & Collateral) falls below 10% of the O/S balance of the account, the account is straightway classified as ‘LOSS’ and when RVS is above 10% but less than 50% of the O/S balance, it is straightway classified as ‘DOUBTFUL’.

RVS: Value of Security (Realisable Value of Security) to reckon NPA is the total of the amounts of security available in each account of the borrower:

1. Value of Principal (Primary) Security,
2. Value of security, other than Primary Security,
3. Value of Credit/Cash Margin,
4. Value of Guarantee (only of the Nature of Guarantee Cover obtaining in the account i.e., (ECGC), (DICGC) (CGFMU) and (CGTMSE).

NET OUTSTANDING (NOS) = Total Outstanding less amount of Unrealised Interest (URI).

Determination of Asset Classification and Assets Code from Standard to NPA as under;

A) Where NPA since the date is up to 12 months from the Current Date:

1. 1. Asset Code will be determined as Sub- Standard (Secured), except for as at ‘b’ below.
   2. Asset Code will be determined as Sub-Standard (Unsecured), if the unsecured portion/RVS as stipulated & ascertained is not more than10% abinitio (Clean Personal loan, Clean OD etc.).
   3. Asset Code will be determined as Doubtful I, if erosion of RVS is more than 50% of the value accepted in the last inspection.
   4. Asset Code will be determined as Loss if erosion of RVS is more than 90% of the value accepted in the last inspection.

B) Where NPA since date is more than 12 months and up to 24 months from the current date:

1. 1. Asset code will be determined as Doubtful I if the RVS is not less than 10% of the NOS.
   2. Asset code will be determined as Loss, if the RVS is less than 10% of the NOS.

C) Where NPA since date is more than 24 months and up to 48 months from the current date:

1. 1. Asset code will be determined as Doubtful II, if the RVS is not less than 10% of the NOS.
   2. Asset code will be determined as Loss, if the RVS is less than 10% of the NOS.

D) Where NPA since date is more than 48 months from the current date:

1. 1. Asset code will be determined as Doubtful III.
   2. Asset code will be determined as Loss, if the RVS is less than 10% of the NOS.

CATEGORIES, CODE AND PERIODS OF NPA ASSETS
Category	Period in category
Sub-Standard (Secured)	Up to 1 year from NPA date
Sub-Standard (Unsecured)	Up to 1 year from NPA date
Doubtful I (D1)	Above 1 year to 2 years from NPA date
Doubtful II (D2)	Above 2 years to 4 years from the NPA date
Doubtful III (D3)	More than 4 years from NPA date
Loss	No time limit

 

PROVISIONING NORMS

The primary responsibility for making adequate provisions for any diminution in the value of loan assets, investments or other assets is that of the bank management and the statutory auditors.

Loss assets: Loss assets should be written off. If loss assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for.

Doubtful assets: Provision for doubtful assets should be done as under;

1. 100 percent of the extent to which the advance is not covered by the realisable value of the security to which the bank has a valid recourse and the realisable value is estimated on a realistic basis.
2. In regard to the secured portion, provision may be made on the following basis, at the rates ranging from 25 percent to 100 percent of the secured portion depending upon the period for which the asset has remained doubtful.

Sub-standard assets: Provision for Substandard assets should be done as under;

1. A general provision of 15 percent on the total outstanding should be made without making any allowance for ECGC guarantee cover and securities available.
2. The ‘unsecured exposures’ that are identified as ‘substandard’ would attract an additional provision of 10 percent, i.e., a total of 25 percent on the outstanding balance.
3. However, given certain safeguards such as escrow accounts available in respect of infrastructure lending, infrastructure loan accounts that are classified as sub-standard will attract provisioning of 20 percent instead of the aforesaid prescription of 25 percent.

SUMMARY OF PROVISION IN NPA ACCOUNTS
NPA Category	Provision Amount (RBI Guideline)
Sub- Standard (Secured)	15% of Net Outstanding
Sub- Standard (Unsecured)	25% of Net Outstanding
Unsecured Exposures in respect of Infrastructure loan accounts where certain safeguards such as Escrow accounts are available	20% of Net Outstanding
Doubtful I (Fully secured by RVS)	25% of Net Outstanding
Doubtful I (Partly secured by RVS)	25% of RVS plus 100% of the unsecured Portion (NOS less RVS)
Doubtful II (Fully secured by RVS)	40% of net Outstanding
Doubtful II (Partly secured by RVS)	40% of RVS plus 100% of the Unsecured Portion (NOS less RVS)
Doubtful III	100% of net Outstanding
Loss	100% of net Outstanding

 

Calculation of Provision in Doubtful Asset

1. Advances covered by ECGC guarantee: In the case of advances classified as doubtful and guaranteed by ECGC, provision should be made only for the balance over the amount guaranteed by the Corporation. Further, while arriving at the provision required to be made for doubtful assets, realisable value of the securities should first be deducted from the outstanding balance in respect of the amount guaranteed by the Corporation and then provision made as illustrated hereunder:

Example

Outstanding Balance	Rs. 4 lakh
ECGC Cover	50 percent
Asset Classification	Doubtful I D1 (say as on March 31, 2024)
Value of security held	Rs. 1.50 lakh

Provision required to be made:

Outstanding balance	Rs. 4.00 lakh
Less: Value of security held	Rs. 1.50 lakh
Unrealised balance	Rs. 2.50 lakh
Less: ECGC Cover (50% of unrealisable balance)	Rs. 1.25 lakh
Net unsecured balance	Rs. 1.25 lakh
Provision for unsecured portion of advance	Rs. 1.25 lakh (@ 100 percent of unsecured portion)
Provision for secured portion of advance	Rs.0.375 lakh (@ 25 percent of the secured portion)
Total provision to be made	Rs.1.625 lakh (as of March 31, 2024)

 

2. Advance covered by CGTMSE: In case the advance covered by CGTMSE guarantee becomes non­performing, no provision need be made towards the guaranteed portion. The amount outstanding more than the guaranteed portion should be provided for as per the extant guidelines on provisioning for non­-performing assets. An illustrative example is given below:

Example

Outstanding Balance	Rs. 10 lakh
CGTMSE Cover	75% of the amount outstanding or 75% of the unsecured amount, whichever is the least
Asset Classification	Doubtful II D2 (say as on March 31, 2024)
Value of security held	Rs. 1.50 lakh

Provision required to be made:

Balance outstanding	Rs.10.00 lakh
Less: Value of security	Rs. 1.50 lakh
Unsecured amount	Rs. 8.50 lakh
Less: CGTMSE cover (75%)	Rs. 6.38 lakh
Net unsecured and uncovered portion:	Rs. 2.12 lakh
Provision for Secured portion @ 40% of Rs.1.50 lakh	Rs.0.60 lakh
Provision for Unsecured & uncovered portion @ 100% of Rs.2.12 lakh	Rs.2.12 lakh
Total provision required	Rs.2.72 lakh

 

Standard Assets: Provision on Standard Assets is done as under;

(i) The provisioning requirements for all types of standard assets stand as below. Banks should make general provisions for standard assets at the following rates for the funded outstanding on a global loan portfolio basis:

1. Direct advances to agricultural and Small and Micro Enterprises (SMEs) sectors at 0.25 percent;
2. Advances to the Commercial Real Estate (CRE) Sector at 1.00 percent;
3. Advances to Commercial Real Estate – Residential Housing Sector (CRE – RH) at 0.75 percent;
4. Housing loans extended at teaser rates and restructured advances as per latest norms;
5. All other loans and advances not included in (a) (b) and (c) above at 0.40 percent.

(ii) The provisions on standard assets should not be reckoned for arriving at net NPAs.

(iii) The provisions towards Standard Assets need not be netted from gross advances but shown separately as ‘Contingent Provisions against Standard Assets’ under ‘Other Liabilities and Provisions Others’ in Schedule 5 of the balance sheet.

Takeout finance: The lending institution should make provisions against a ‘takeout finance’ turning into NPA pending its takeover by the taking-over institution. As and when the asset is taken-over by the taking-over institution, the corresponding provisions could be reversed.