Definition of NPA and Asset Classifications

(This article  explains the definition of non-performing assets (NPAs), classification of assets, Income recognition, and provisioning requirement under prudential norms for all types of accounts including NPA norms for Agricultural loans and especially KCC)

Internationally income from Non-Performing Assets (NPAs) is not recognized on an accrual basis but is booked as income only when it is received. In line with the international practices and terms of recommendations made by Mr. Narasimham’s committee on the financial system, RBI has introduced prudential norms for income recognition and asset classifications for Indian banks and financial institutions,  to ensure proper provisioning and transparency in the published accounts. In agreement with the prudential norms for loans & advances,  provisions are made by the banks based on the classification of assets into standard assets and prescribed NPA categories viz. Sub-standard, bad, and doubtful, and loss accounts.

Definition of Non-performing Assets (NPA): An asset, including a leased asset, is called NPA when the asset ceases to generate income for the bank. If interest and or installment of the principal amount of the loan remain overdue for more than 90 days, of term loan or the account remains ‘out of order’ in case of overdraft/Cash Credit account or the bills purchased /discounted remain overdue for more than 90 days the account, such accounts will be classified as NPA.

In case of agricultural advance, the account is classified as NPA, if the installment of principal or interest thereon remains overdue for two crop seasons for short-duration crops. In the case of long-duration crop loans, the account will be classified as NPA if the outstanding is overdue for more than one crop season.

A KCC account can be classified as ‘standard’ when the balance outstanding is less than or equal to the drawing limit [short-term (crop) loan] at any point of time during the preceding year. In other words, the short-term loan (with the major component of crop loan) sanctioned on the KCC can be given the same treatment as a “cash credit” account to apply prudential norms and should not be treated as “out of order” if the balance outstanding is less than or equal to the drawing limit and each drawl is repaid within 12 months. Term loans under KCC have fixed repayment schedules and are to be governed by extant prudential norms.

What is ‘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.

What is ‘Out of order’ status?

An account should be treated as ‘out of order’ if the outstanding balance remains continuously more than the sanctioned limit/drawing power. In cases 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 the Balance Sheet or credits are not enough to cover the interest debited during the same period, these accounts should be treated as ‘out of order’.

Categories of Assets

Based on the period, for which the asset remained nonperforming and the realisability of the dues, Banks are required to classify their assets into the following categories.

(i)  Loss Assets: A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value. If the loan is not repaid even after it remains a sub-standard asset for more than 3 years, it may be identified as unrecoverable by internal/external audit and it would be called a loss asset

(a)  The entire assets should be written off after obtaining necessary approval from the competent authority or as per the provisions of the Co-operative Societies Act / Rules. If the assets are permitted to remain in the books for any reason, 100 per cent of the outstanding should be provided for.

(b) In respect of an asset identified as a loss asset, full provision at 100 per cent should be made if the expected salvage value of the security is negligible.

(ii) Doubtful Assets: If an account remains in the substandard category for 12 months, the account will be classified as ‘Doubtful Asset.’  A loan is classified as doubtful.

In this case of doubtful assets, the bank needs to make provisioning as follows:
Up to one year: 25% of outstanding amount in case of Secured loans; 100% of outstanding amount in case of Unsecured loans.
Above One year up to three years: 40% of outstanding amount in case of Secured loans; 100% of outstanding amount in case of Unsecured loans.
If the loan is not repaid even after it remains a sub-standard asset for more than 3 years: the bank needs provisioning of 100% of the outstanding amount in case of Secured loans; as well as 100% of the outstanding amount in case of Unsecured loans.

iii) Sub-standard Assets: If interest and or installment of principal amount of loan remain overdue for more than 90 days, of term loan or the account remains ‘out of order’ in case of overdraft/Cash Credit account or the bills purchased /discounted remain overdue for more than 90 days the account. If the borrower does not pay dues for 90 days after the end of a quarter; the loan becomes an NPA- substandard asset and is termed a ―Special Mention Account(SMA).

Special Mention Account (SMA) is an account that is exhibiting signs of incipient stress resulting in the borrower defaulting in the timely servicing of her debt obligations, though the account has not yet been classified as NPA. As early recognition of such accounts enables banks to initiate timely remedial actions to prevent their potential slippages into NPAs,

In case of agricultural advance, the account is classified as NPA, if the installment of principal or interest thereon remains overdue for two crop seasons for short-duration crops. If the loan is for long duration crop, the account is classified as NPA if the outstanding for one crop season such accounts also classified as NPA –Sub standard account. If an account remains in the substandard category for 12 months, then the account will be classified as a ‘Doubtful Asset.’

In this case of sub-standard accounts, a bank has to make provisioning as follows:
15% of the outstanding amount in case of Secured loans
25% of the outstanding amount in case of Unsecured loans

The restructured loans classified under the standard category would also need a provision of two per cent in the first two years from the date of restructuring.

(iv) Standard Assets: If the loan accounts or the bills purchased /discounted that do not fall under NPA classification are called standard accounts. As per the norms, banks have to make a general provision of 0.40% for all standard assets (loans and advances) except that given towards agriculture and small and medium enterprise (SME) sector.

The provisions on standard assets should not be reckoned for arriving at net NPAs.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 the balance sheet. It is clarified that income recognition on and provisioning against NPAs are two different aspects of prudential norms and provisions as per the norms are required to be made on NPAs on total outstanding balances. The fact that income on an NPA has not been recognised cannot be taken as a reason for not making a provision.

Banks should make provisions for NPAs at the end of each calendar quarter i.e. as at the end of March/ June/ September/ December, so that the income and expenditure account for the respective quarters as well as the P&L account and balance sheet for the year-end reflects the provision made for NPAs.

Income recognition: Banks all over the world do not recognize the income from non-performing assets on an accrual basis.  Income is booked only when it is received. In India also banks do not charge and show interest income from NPA accounts. However, interest on advances against term deposits, NSCs, IVPs, KVPs, and Life policies are recognized as income when adequate margin is available in the accounts.

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 concerning past periods, if uncollected.

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