Loan provisioning process explained with examples

The potential loan losses arise to banks and financial institutions  due to default of repayments  from borrowers or renegotiated terms of a loan or one time settlement that incur lower than previously estimated repayments. The provision for loan loss is the money banks and financial institutions set aside to cover these potential losses on their loan assets. Banks are required to make provisions both for their standard assets (loans and advances which are regular) and non-performing assets (bad loans) as prescribed under prudential norms by the banking regulator.

Before going through illustrations let us briefly sum-up requirement of provisioning under prudential norms.

Standard assets:  Banks are required to make a general provision for standard assets as under;

1. Direct advance to agriculture or small and micro enterprise : 0.25%,
2. Commercial real estate residential 0.75%, for real estate commercial 1% and teaser housing loan 2%.
3. For all other standard assets (loans and advances) : 40%

For NPA accounts banks need to make provisioning as under;

1. Secured substandard assets 15% of outstanding amount
2. Unsecured substandard loans 25% of outstanding amount.
3. Secured Doubtful: Up to one year: 25% of outstanding amount and for unsecured advance 100% of outstanding amount.
4. Doubtful 1-3 years: 40% of outstanding in case of Secured loans; 100% of outstanding amount in case of unsecured loans.
5. Doubtful for more than 3 years: 100% of outstanding amount both in case of Secured loans and unsecured loans..
6. Loss Assets: The entire assets should be written off or if permitted to remain in the books for any reason, 100% of the outstanding should be provided for.

Further, while arriving at the provision required to be made for doubtful assets, realizable value of the securities should first be deducted from the outstanding balance in respect of the amount guaranteed by the CGTMSE /ECGC/ CRGFTLIH etc.

Illustration 1

XYZ Bank provides following information about its loans and advance portfolio, as of March 31, 2019. Total loans Rs 200000 Crore, standard accounts Rs190000 Crore includes direct Agriculture and SME loans of Rs 50000 Crore. Substandard 2000 Crore out of which unsecured substandard 1000 crores, Doubtful up to 1 year Rs.4000 crore, Doubtful above 1 year up to 3 year Rs.1000 crore, Doubtful above 3 years 600 crore and loss account Rs.200 crore, all doubtful loans are secured loans.   Answer to following questions.

1.01. What is the provision of standard accounts?

Solution: For provision for direct advance to agriculture or small and micro enterprise is 0.25%, for other standard assets 0.40%

190000-50000= 140000*0.40%= 560 Crores, 50000*0.25%= 125 crores

Ans.: Total 560+125= 685 Crore

1.02. What is the amount of provisions made on substandard loan accounts?

Solution: 15% of outstanding amount in case of Secured loans,  25% of outstanding amount in case of Unsecured loans.

Secured loans 3000 Crore   and unsecured Rs.1000 Crore

Ans.: 3000@ 15% +1000@ 25% => 450+250= 700 crore

1.03.      What is the amount of provision on doubtful loan accounts?

Information provided: doubtful upto 1 year Rs 4000 Crore , doubtful above 1 year upto 3 year Rs1000 Crore and doubtful above 3 years Rs 600 Crore  and all doubtful loans are fully secured?

4000*25%= 1000,  1000*40%=400, 600*100%=600

1000+400+600= 2000 Crore

1.04. What is the total provision on NPA loan?

Solution: total of provision made on substandard, doubtful and loss assets

Ans.:700+2000+ 400= 3100 crore

1.05.      What is the total provision on Standard and NPA loans?

Solution: total provision is provision made on standard asset and provision made on NPA

3100+ 685= 3785 Crore

1.06. What is the provision Coverage ratio of the Bank?

Solution: Gross NPA= Total advance- Standard assets=> 200000- 190000= 10000 Crores

PCR percent = (Cumulative provisions / Gross NPAs)*100
Ans.: (3100/10000)*100=31%

1.07. What is the amount of Net NPA?

Solution: Total NPA- total provision= 10000-3100= 6900 Crore

1.08.      What is the percentage of Net NPA?

Solution: Percentage of Net NPA= (Net NPA/ Total advance) * 100

Ans.: (6900/200000)*100= 3.45%

Illustration 2:

The XYZ Bank provides following information about its NPA accounts March 31 2019?

Total loans Rs 200000 Crore,  standard accounts Rs.190000 Crore  includes direct Agriculture and SME loans of Rs 50000 Crore, substandard Rs 4000Crore out of which unsecured substandard Rs.1000 Crore doubtful  upto 1 year Rs.4000 Crore , doubtful above 1 year upto 3 year Rs.1000 and doubtful above 3 years Rs 600 Crore and loss accounts Rs 400 Crore.

2.01       If the security value in Doubtfull-1 Category accounts is Rs.3000 Crore what will be the provision   for Doubtfull -1 category accounts?

Solution: Doubtful upto 1 year is Rs.4000 Crore , Secured 3000, unsecured 1000, secured @25%, unsecured @100%

3000* 25%= 750, 1000@ 100%= 1000,

Ans.: 750+1000= 1750

2.02.      If the security value is Rs.300 Crore in Doubtful -2 category account, the provision will be

Solution: Doubtful above 1 year upto 3 year Rs 400 Crore , secured 300 crore, therefore unsecured 100 crore

300*40%= 120+ 100= 220 Crore

Illustration 3:

The present outstanding of a loan account is Rs.10 lac, value of security held is 4 lakh, ECGC cover is 50%, the account remained doubtful for more than 2 years. What is the amount provision required to above loan?

Solution:

Outstanding 10 lac – Less: Value of security held Rs.4 lac= Rs.6 lac

= > Unrealisable balance Rs.6 lakh Less 50% ECGC Cover Rs.3 lakh = 3 lac (this is the  net unsecured balance)

Provision for unsecured portion of advance 3 lac (@ 100 percent of unsecured portion = 3 lakh

Provision for secured portion of advance 4 lac @ 40%  is Rs.160000/-

Ans.: Total provision Rs.300000 + Rs160000= Rs.460000/-