CA Amresh Vashisht
The Institute of Chartered Accountants has already issued 660 Page Guidance Note Bank Statutory Audit 2015.The publication is a regular annual publication with the foreword note of new President in Office. This is the Tenth Edition. The first Edition was issued in November 1994. This time the publication was in right time but this year, the allotments and appointments are taking a long time. However the annual ritual of Bank auditing 2015 is at our door step. This guidance note be referred as GEETA TO BANK AUDIT. An attempt is made through this article to have a quick view over many issues like Categorization, Classification and provisioning of Advances.
The Third Schedule to the Act requires classification of advances made by a bank from three different angles, viz., nature of advance, nature and extent of security, and place of making advance (i.e. whether in India or outside India). Accordingly, these advances are to be classified in Schedule 9 to the balance sheet
The core area of Statutory Audit or say Balance sheet audit rotates around identification of NPA’s. Banks at their own part classify their advances as NPA, we as auditor has to vouch it authentically and to suggest fresh NPA’s, if we found it inadequately provided.
CATEGORIZATION OF A BORROWER ACCOUNT AS NPA
Banks provide advances to their customers in various forms like, cash credit, term loans, overdrafts, and purchase or discounting of bills etc.
Term loans are repayable in installments spread over a period of time generally after the moratorium based on the requirement and cash generation capability of the borrower. In case of Defaults Bank may recall the entire loan outstanding as on date including the installments which have not yet fallen due for payment. The amount and periodicity of repayment is fixed and duly recorded in the documents. The amount and the periodicity may be uniform throughout the life of the loan, or either or both.
Here Term loan account will be treated as NPA if interest and/or installment of principal remain overdue for a period of more than 90 days.
CASH CREDITS , OVERDRAFTS & WCDL
Cash credit , popularly known as CC limit is provided mainly to individuals or business entities engaged in manufacturing and /or trading merchandise goods. It is used as working capital and is repayable on demand. The cash credit facility is granted against the security of stocks, crops, book debts related to the business. Every bank is having its own sets of rules to sanction such limits are within a broad guidelines issued by the regulator. These are generally on ‘floating’ interest rate basis based on Bank’s base rate. It should ensure that drawings in the working capital accounts are covered by the adequacy of current assets, since current assets are first appropriated in times of distress.
The correct calculation of DP (Drawing Power) in a CC account is very important. The margins against CC (Stocks) are generally different from the margins against CC (Book Debts). And stocks should be only the paid stocks i.e. minus the creditors. The borrower can’t go in for double financing: Till the time you haven’t paid your creditors, you are not entitled to have those credit purchases financed by bank.
There might be situations where the DP for stocks works out to be a negative figure—the creditors might be more than the value of stocks. Should you net this negative figure off with the DP calculated with reference to the book debts? Generally, the branches would ignore the negative figure and calculate the DP on book debts only.
The CC limits fall due for renewal after a year. A renewal delayed beyond a period of 180 days would result in the account being declared an NPA, in terms of the RBI Master Circular dated 01st July 2013.
A cash credit or overdraft account will be treated as NPA (Out of order or irregular) if the account remains out of order for a period of more than 90 days or if irregular drawings are permitted in the account for a continuous period of 90 days.
An account is treated as “out of order” if any of the following conditions is satisfied:
a. The outstanding balance remains continuously in excess of the sanctioned limit/drawing power.
b. Though the outstanding balance is less than the sanctioned limit/drawing power but there are no credits continuously for 90days as on the date of balance sheet or credits are not enough to cover the interest debited during the period.
An account is treated as “irregular” if the following condition is satisfied:
a. The outstanding in the account based on drawing power calculated from stock statements older than three months even though the unit may be working or the borrower’s financial position is satisfactory.
Regular and adhoc credit limits need to be reviewed / regularised not later than three months from the due date/date of adhoc sanction. In case of constraints such as non availability of financial statements and other data from the borrowers, the branch should furnish evidence to show that renewal/ review of credit limits is already on and would be completed soon. In any case, delay beyond six months is not considered desirable as a general discipline. Hence, 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.
BILLS PURCHASED AND DISCOUNTED
The finance against bills is meant to finance the actual sale transactions. This can be Purchase of bills by the bank if these are payable ‘on demand’ or Discounting of bills by the bank if these are usance (or time) bills or Advance against bills under collection from the drawees, whether sent for realization through the bank or sent directly by the drawer to the drawees. The RBI has issued guidelines for regulation of discounting and rediscounting of bills (Ref. Master Circular No. DBOD.No.Dir.BC.16/13.03.00/2014-15, dated July 01, 2014, “Loans and Advances-Statutory and other Restrictions”
The bills purchased/discounted account should be treated as NPA if the bill remains overdue for a period of more than 90 days.
All loans given for agriculture sector are agriculture loans . Advances are made to agriculturists for crops. When the produce is harvested, processed and sold, the money is repaid to the bank. The basis of calculating the amount of the advance is the estimated crop of the season. For the purpose “long duration” crops would be crops with crop season longer than one year and crops, which are not “long duration” crops, would be treated as “short duration” crops. This depends upon the area under cultivation, expected yield, etc. Separate advances are made for each season’s crop. A loan granted for short duration crops will be treated as NPA, if the installment of principal or interest thereon remains overdue for two crop seasons. A loan granted for long duration crops will be treated as NPA, if the installment of principal or interest thereon remains overdue for one crop season.
However, RBI, vide its circular no. RPCD.CO.Plan.BC. 51 /04.09.01/2010-11 dated February 2, 2011 on “Classification of loans against gold jewellery” clarifies that loans sanctioned to NBFCs for on-lending to individuals or other entities against gold jewellery, are not eligible for classification under agriculture sector. Similarly, investments made by banks in securitized assets originated by NBFCs, where the underlying assets are loans against gold jewellery, and purchase/assignment of gold loan portfolio from NBFCs are also not eligible for classification under agriculture sector
AGRICULTURE ADVANCES AFFECTED BY NATURAL CALAMITIES
Relaxation in assets classification norms in credit facilities granted to affected borrowers in District & Block Notified by State Government, as cyclone or other natural calamities affected:
Advances against FDR/NSCs/KVP/LIP
Advances against Term Deposits, NSCs eligible for surrender, Kisan Vikas Patras and Life Insurance Policies, need not be treated as NPAs although interest thereon has not been paid for 90 days provided adequate margin is available in the accounts. However, advances against gold ornaments, Govt. securities and all other securities are not covered by this exemption.
For the purpose of calculating the margin, value of security should be taken as under:
a. In case of advances against Term Deposit in the nature of recurring and reinvestment deposits, the principal and interest accrued thereon shall be taken into account.
b. In case of advances against LIC policies, the latest surrender value of the policy may be taken into account.
c. In case of advances against NSCs eligible for surrender and KVPs the interest accrued on the value of security should be taken into account.
In respect of consortium advances, each member bank may classify the borrower accounts according to its own record of recovery 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 one bank and /or where the bank receiving remittances 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. The banks participating in the consortium should, therefore, arrange to get their share of recovery transferred from the lead bank or get an express consent from the bank for the transfer of their share of recovery, to ensure proper asset classification in their respective books.
ADVANCES TO STAFF
As in the case of project Finance, in respect of housing loans or similar advances granted to staff members where interest is payable after recovery of principal, interest need not be considered as `overdue’ from the first quarter onwards. Such loans/advances should be classified as NPA only when there is default in payment of interest on due date of payment.
Regularization of Account by Year-end
If the accounts of the borrowers have been regularised before the balance sheet date by repayment of overdue amounts through genuine sources (and not by sanction of additional facilities or transfer of funds between accounts) the accounts need not be treated as NPA.
It should be ensure that the account remains in order subsequently and a solitary credit entry made in the account on or before the balance sheet date which extinguishes the overdue amount of interest or installment of principal is not reckoned as the sole criterion for treating the account as standard asset.
It is to clarify here that the asset classification of borrower accounts where a solitary or a few credits are recorded before the balance sheet date should be handled with care and without scope for subjectivity. Where the account indicates inherent weakness on the basis of the data available, the account should be deemed as NPA. In other genuine cases, the branches must furnish satisfactory evidence to the Statutory Auditors about the manner of regularization of the account to eliminate doubts on their performing status.
DETERMINATION OF NPA S: BORROWER WISE, NOT FACILITY WISE
All the facilities granted to a borrower will have to be treated as NPA and not a particular facility or part thereof which has become NPA. If the amount in default of any borrower is outstanding in default account i.e. LC-default account/ LG-default account / DPG default account / Co-accepted bills default account, the balance outstanding in that account also should be treated as a part of the borrower’s principal operating account for the purpose of application of prudential norms on income recognition, asset classification and provisioning.
The bills discounted under LC favoring a borrower may not be classified as a NPA, when any other facility granted to the borrower is classified as NPA. However, in case documents under LC are not accepted on presentation or the payment under the LC is not made on the due date by the LC issuing bank for any reason and the borrower does not immediately make good the amount disbursed as a result of discounting of concerned bills, the outstanding bills discounted will immediately be classified as NPA with effect from the date when the other facilities had been classified as NPA.
NET WORTH OF BORROWER /GUARANTOR OR AVAILABILITY OF SECURITY
Availability of security or net worth of borrower/guarantor should not be taken into account for the purpose of treating an advance as NPA or otherwise except in some defined cases.
Accounts where there is erosion in the value of security / frauds committed by borrowers:
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 need not go through the various stages of classification. In case of such serious credit impairment the asset should be straightaway classified as doubtful / loss as appropriate:
a. Erosion in the value of security can be reckoned as significant when the realisable value of the security is less than 50 per cent of the value assessed by the bank or accepted by RBI at the time of 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.
b.If the realizable value of security, as assessed by the bank / approved valuer / RBI is less than 10 percent of the outstanding in the borrower accounts, the existence of security should be ignored and the asset should be straightaway classified as loss asset and provisioning made accordingly.
Any other credit facility should be treated as NPA if any amount to be received in respect of that facility remains overdue for a period of more than 90 days.
ASSET CLASSIFICATION OF A BORROWER ACCOUNT
All accounts need to be classified into four categories taking into account the degree of well defined credit weaknesses and extent of dependence on collateral security for realisation of the dues as given under :-
1. Standard Assets
Standard asset is one which does not disclose any problem and which does not carry more than normal risk attached to the business. Such an asset is not an NPA. However, Central Govt. Guaranteed advances, although categorized as NPA for the purpose of Income Recognition, are to be treated as Standard Assets (Govt Guaranteed) unless Govt repudiates its guarantee when invoked.
With effect from the year ending 31.3.2006 State Govt. guaranteed advances shall be classified as sub standard or doubtful or loss, after interest / principal / any other amount due to the bank remains overdue for more than 90 days.
Further, advances against term deposits, NSCs eligible for surrender, Indira Vikas Patra, Kisan Vikas Patras and Life Insurance Policies, are to be classified as Standard assets provided adequate margin is available.
Re-structuring/rescheduling ( installment and /or interest )/re-negotiation of the terms of loan agreement (a) before commencement of commercial production & (b) after commencement of commercial production but before the asset has been classified as sub-standard, would not cause a standard asset to be classified in the sub-standard category provided the loan/credit facility is fully secured.
2. Sub-standard Assets
With effect from 31st March, 2005 a sub-standard asset is one, which has remained NPA for a period less than or equal to 12 months.
In such cases, the current net worth of the borrower/guarantor or the current market value of the security charged is not enough to ensure recovery of the dues to the bank in full. In other words, such an asset will have well defined credit weaknesses that jeopardize liquidation of the debt and are characterised by the distinct possibility that the bank will sustain some loss, if deficiencies are not corrected.
In the context of rescheduling of installments of principal alone or interest element, after commencement of commercial production and classifying the asset as sub-standard, the account will be eligible to be continued in sub-standard category for the specified period, provided the loan/credit facility is fully secured. Such restructured accounts (whether principal or interest), would be eligible to be upgraded to the standard category only after the specified period i.e. Period of one year after the date when first payment of interest or of principal, whichever is earlier, falls due, subject to satisfactory performance during the period.
3. Doubtful Assets
With effect from 31st March, 2005 an asset is classified as doubtful if it remained in the sub-standard category for 12 months.
A loan classified as doubtful has all the weaknesses inherent in that classified as sub-standard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable.
4. Loss Assets
A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI Inspectors but the amount has not been written off, wholly or partly. If the realisable value of the security as assessed by the bank / approved valuer / RBI is less than 10% of the outstanding in the borrowal accounts, the existence of security should be ignored and the asset should be straightaway classified as loss asset. The unsecured exposure identified as sub-standard, as mentioned at Item 3.3 Sub-standard under 3 – Guidelines on Provisioning is the only exception.
PROVISIONING OF A BORROWER ACCOUNT
The provisioning requirement for different categories of assets are given as under:
i) Loss Assets
In case of Loss Assets 100% of the outstanding should be provided for regardless of security.
ii) Doubtful Assets
100 percent of the extent to which the advance is not covered by the realizable value of the security to which the bank has a valid recourse and the realizable value is estimated on a realistic basis.
In regard to the secured portion, provision may be made on the following basis, at the rates ranging from 20 percent to 100 percent of the secured portion depending upon the period for which the asset has remained doubtful:
|Period for which the advance has remained in ‘doubtful’ category||Provision requirement (%)|
|Up to one year||20|
|One to three years||30|
|More than three years||100|
A general provision of 10 percent on total outstanding should be made without making any allowance for DICGC/ECGC guarantee cover and securities available.
iv) Standard Assets (to be made at HO).
In standard assets, provisioning requirements [w.e.f.05.11.09], (category-wise) are summarized below:
|S. No.||Category of standard asset||Rate of Provisioning|
|(a)||Direct Advances to agricultural and SME Sectors||0.25%|
|(b)||Commercial Real Estate Sector||1.00%|
|(c)||All other loans and advances not included in (a) and (b) above||0.40%|
V) Advances covered by ECGC/ DICGC guarantee
In the case of advances guaranteed by DICGC/ECGC, provision should be made only for the balance in excess of the amount guaranteed by these Corporations. 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 these Corporations and then provision should be made
VI) Advance covered by CGTSI guarantee
In case the advance covered by CGTSI guarantee becomes non-performing, no provision need be made towards the guaranteed portion. The amount outstanding in excess of the guaranteed portion should be provided for as per the extant guidelines on provisioning for non-performing advances.
Post-shipment supplier’s credit to the extent payment has been received from Exim Bank under the guarantee cum refinance programme is exempted from provisioning requirement.
The banks are well equipped with three wonderful tools in their hands to prevent fraud and detect errors: CIBIL, CERSAI and CHARTERED ACCOUNTANTS. In a present scenario, every bank should rely on the finding of these three tools. Some of us have neither got the time nor the patience to drop a letter to the previous auditor in terms of clause 8 of the Second Schedule. But what you can’t afford to overlook is the previous auditors’ statutory branch audit report! Comb through it. Also have on your table the concurrent audit report, the revenue audit report, if any conducted during the year, the bank’s internal inspection report and the RBI Inspectors’ report. The general comments we are called upon to make in the LFAR regarding credit appraisal, end-use of funds, compliance with KYC norms, documentation—take care that none of what you say is at odds with what’s stated in the concurrent auditor’s report.