Prudential norms for Income Recognition, Asset Classification, and provisioning

Prudential norms:

The objective of prudential regulation is to protect the stability of the financial system and protect deposits so its main focus is on the safety and soundness of the banking system and on nonbanking financial companies (NBFCs) that take deposits from the public.

Provisioning for bad debts under the Health Code-based system for The classification of advances was first introduced by RBI on 1st April 1980 (FY 1980-81). Accordingly, banks were allotting health codes to their loan accounts for the purposes of provisioning. The Reserve Bank of India decided in April 1992 to introduce a risk-asset ratio system for banks (including foreign banks) in India as a capital adequacy measure in line with the Capital Adequacy Norms prescribed by Basel Committee. With the introduction of prudential norms in 1992, the Health Code-based system for the classification of advances has ceased to be a subject of supervisory interest. RBI has issued revised/ updated Master Circular on Prudential Norms for Income Recognition, Asset Classification (IRAC), and Provisioning pertaining to Advances from time to time, which consolidates the RBI Guidelines/ Directions/ Instructions/ Revisions on the subject upto 31/03/2023.

In terms of RBI guidelines on Prudential norms on Income Recognition, Asset Classification, and Provisioning pertaining to Advances, banks are required to recognise incipient stress in the borrower accounts and classify them as Special Mention Accounts (SMA) and, if required, subsequently classify them as Non-Performing Asset (NPA). According to the prudential accounting norms, interests should not be debited on an accrual basis but only on a cash basis.

Asset Classification:

Banks are required to make provisions on their assets, based on the period, for which the asset remained nonperforming and the realisability of the dues. Please find an explanation of some of the aspects relating to NPA asset classification by clicking ‘DEFINITION OF NPA AND ASSET CLASSIFICATIONS’

Provisioning under prudential norms:

Based on the asset classification, banks, and financial institutions have to make adequate provisions as per RBI guidelines. Click ‘LOAN PROVISIONING UNDER PRUDENTIAL NORMS’ to know if the quantum of provisioning is required as per prudential norms.

Banks are not supposed to charge/ debit interest in any NPA account and for taking to income account (i.e. income recognition), including for Government guaranteed accounts. However, interest on advances against Term Deposits/ NSC/ IVP/ KVP/ Life policies may be recognised on the due date (i.e. without realisation), provided adequate margin is available.

Reversal of income credited for the past period:

Once,  any advance, including bills purchased and discounted, becomes NPA, the entire interest accrued and credited to the income account in the past periods, should be reversed if the same is not realised.  This will apply to Government guaranteed accounts also.  The 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.

Also, the Bank Management and Statutory Auditors are responsible for ensuring that requisite/ adequate provisioning has been made, based on the ‘age of assets having been classified as NPA’ and the realisable value of the available security under respective accounts, for compliance with the Prudential Norms.

RBI clarification:

RBI Notification 2021-2022/158 dated 15/02/2022: In view of several queries received seeking certain clarifications, RBI has advised as under:

i) The definition of ‘out of order’, as clarified in the Circular, shall be applicable to all loan products being offered as an overdraft facility, including those not meant for business purposes and/ or which entail interest repayments as the only credits.

ii) The ‘previous 90 days period’ for determination of the “out of order” status of a CC/ OD account shall be inclusive of the day for which the day-end process is being run.

iii) In case of borrowers having more than one credit facility from a lending institution, loan accounts shall be upgraded from NPA to standard asset category only upon repayment of entire arrears of interest and principal pertaining to all the credit facilities.

iv) The circular does not make any changes to the requirements related to reporting information to CRILC, which will continue to be governed in terms of extant instructions for respective entities.

v) The circular does not, in any way, interfere with the extant guidelines on the implementation of Ind-AS by NBFCs.

vi) Paragraph 10 of the Circular stipulates that loan accounts classified as NPAs may be upgraded as ‘standard’ assets only if entire arrears of interest and principal are paid by the borrower.

The policy of income recognition should be objective and based on the record of recovery rather than on any subjective considerations. In view of the same, Banks are urged by the banking regulator to ensure that while granting loans and advances, realistic repayment schedules may be fixed on the basis of 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 advance.

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