In the current era the word NPA is well heard or well read by us. The banking industry is facing a high NPA problem which leads to downtrend of profitability. Let us try to understand the NPA mechanism in a simple and lucid manner.
In simple words NPA stands for Non Performing Assets. If we do not gain anything from the assets, it will be called non performing. If we do not receive interest and/or installments in a loan for a specific period, it will turn into NPA.
MANAGEMENT OF NPA
The management of NPA begins at the time of receiving an application of loan from the customer. If the character or Income is not well going, the future of the loan will be NPA.
The bank staff should be well versed with analytical skill and should be well enough to decide about loan sanction limit to a probable customer. NPA management can’t be done from sitting in an office between four walls, but review of current affairs and market trends is most important. The various tools of recovery are also of utmost importance. The knowledge of relevant acts is also a must.
HISTORY OF NPA
The concept of NPA is introduced by RBI to reflect a bank’s actual financial health in its balance sheet and as per the recommendations made by the Committee on Financial System (Chairman Shri M. Narasimham). The Narasimham committee studied the prevailing financial system, identified its shortcomings and weaknesses and made with ranging suggestions and recommendations in line with internationally accepted norms. The committee report was first tabled in Parliament on December 17, 1991. Based on the recommendations of the Committee on “Financial System Reforms”, the RBI evolved prudential norms on Income recognition ,Asset classification and Provisioning and issued revised instructions to banks in April 1992. The provisioning should be made on the basis of the classification of assets into different categories. The above instructions of RBI have since been implemented by banks from the financial year ended March 1998.
Before 31-03-2001, the concept of PAST DUE was in practice to consider any asset as Non Performing Asset. An amount is considered as past due, when it remains outstanding for 30 days beyond the due date. An asset becomes non-performing when it ceases to generate income for the bank. A non performing asset was defined as credit in respect of which interest and / or installment of principal has remained ‘past due’ for a specific period of time. The specific period was reduced in a phased manner as under:
Year ended March, 31 Specific period
1993 4 quarters
1994 3 quarters
1995 2 quarters
DUE AND OVERDUE
Any amount becomes due on the fixed time of payment. It becomes overdue if it is not paid on that due date. In the same manner in customer banker relationships any amount due to the bank under any credit facility, if not paid by the due date fixed by the bank becomes overdue.
With effect from 31-03-2001, With a view to moving towards international best practices and to ensure greater transparency, ’90 days’ overdue norms for identification of NPAs have been made applicable from the year ended March 31, 2004. As such, with effect from March 31, 2004, a non-performing asset shall be a loan or an advance
i. interest and/ or installment of principal remain overdue for a period of more than 90 days in respect of a term loan,
ii. the account remains ‘out of order’ as indicated at paragraph below, in respect of an Overdraft/Cash Credit (OD/CC),
iii. the bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,
iv. the installment of principal or interest thereon remains overdue for two crop seasons for short duration crops,
v. the installment of principal or interest thereon remains overdue for one crop season for long duration crops,
vi. the amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitisation transaction undertaken in terms of guidelines on securitisation dated February 1, 2006.
vii. in respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment.
viii. Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.
“An account should be treated as ‘out of order’ if the outstanding balance remains continuously in excess of 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 or credits are not enough to cover the interest debited during the same period, these accounts should be treated as ‘out of order’ “.
Regular and ad-hoc credit limits need to be reviewed / regularised not later than three months from the due date / date of ad-hoc 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 / ad-hoc credit limits have not been reviewed or have not been renewed within 180 days from the due date / date of ad-hoc sanction will be treated as NPA, which period will be reduced to 90 days with effect from March 31, 2004.
Banks 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. Considering the practical difficulties of large borrowers, stock statements relied upon by the banks for determining drawing power should not be older than three months. The outstanding in the account based on drawing power calculated from stock statements older than three months would be deemed as irregular. A working capital borrowal account will become NPA if such irregular drawings are permitted in the account for a continuous period of 90 days (with effect from March 31, 2004).
If Government guaranteed advances become NPA, the interest on such advances should not be taken to income account unless the interest has been realised.
Advances against term deposits, NSCs eligible for surrender, IVPs, KVPs and Life policies need not be treated as NPAs although interest thereon may not have been paid for more than 90 days provided adequate margin is available in the accounts.
The investments are also subject to the prudential norms on income recognition. Banks should not book income on accrual basis in respect of any security irrespective of the category in which it is included, where the interest / principal is in arrears for more than 90 days.
The system of identification of NPA should be an ongoing basis. Banks should also make provisions for NPAs as 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.
Here, we should make clear that the account turns to NPA due to 90 days norms. In the loan accounts having monthly installments, generally three installments fall during 90 days and as such 90 days overdue consists of three overdue installments. But it should not be made a thumb rule of three months overdue, as the days count varies on the basis of the respective months. In a non-leap year the overdue of December 31 will turn into NPA on March 31. But in a leap year the overdue of January 1 will turn into NPA on March 31.
We should also make clear about chronological order of transactions is important in term loans. Every debited interest must be followed by credit of its repayment. It means that repayment must be done after debit of interest in case of term loan. But in case of cash credit overdradt account chronological order of debit credit is not necessary but total credit of last 90 days should cover total debited interest of last 90 days.
Interest realised on NPAs may be taken to income accounts 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.
On an account turning NPA, banks should reverse the interest already charged and not collected by debiting the 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.
The treatment of an asset as NPA should be based on the record of recovery. Banks should not treat an advance as NPA merely due to existence of some deficiencies which are of temporary nature such as non-availability of adequate drawing power, balance outstanding exceeding the limit, non-submission of stock statements and the non-renewal of the limits on the due date, etc. Where there is a threat of loss, or the recoverability of the advances is in doubt, the asset should be treated as NPA.
In respect of a borrower having more than one facility with a bank, all the facilities granted by the bank will have to be treated as NPA and not the particular facility or part thereof which has become irregular. However, in respect of consortium advances or financing under multiple banking arrangements, each bank may classify the borrowal accounts according to its own record of recovery and other aspects having a bearing on the recoverability of the advances. Banks can’t classify all the a/cs of a group ( i.e. common management by one or more directors / partners having common in different firms) as NPA on ground of any one facility being NPA. The classification of NPA is borrower wise and not groupwise. To classify the NPAs borrower wise, borrower number and UCIC Unique Customer Code and PAN of the borrower may be considered as base. i.e. all the loan accounts having the same PAN are to be treated as NPA, if any one of them has been turned to NPA.
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. 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 lead bank for the transfer of their share of recovery, to ensure proper asset classification in their respective books.
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. Here, it should be kept in mind that the full overdue is to be paid in the account and not the overdue before 90 days. The benefit of overdue below 90 days is given while converting standard to NPA. But while converting NPA to Standard, no such benefit counted and full arrears – full overdue interest and installments is to be paid. Once a loan/advance account turns into NPA due to installments of principal and/or interest remaining overdue for more than 90 days, it can be upgraded to standard category only upon repayment of the entire overdue amount and not just the amount which is overdue for more than 90 days.
SLIPPAGE TO NPA
An account must be paid regularly. It should not become overdue. If an account remains overdue for more than one month, it is a red signal. If it remains overdue for more than two months, it heighten the possibility of turning into NPA. That’s why RBI has specially created another category of SPECIAL MENTION ACCOUNT – SMA, which is a pool between regular standard and NPA account. There are three categories of SMA.
SMA0 overdue up to 30 days
SMA1 overdue for 31 to 60 days
SMA2 overdue for 61 to 90 days
It becomes necessary to monitor SMA accounts to prevent them becoming NPA. Recovery efforts should be made strong for such potential stress Probabl NPAs.
Banks should classify their assets into Performing and Non Performing Assets. Performing assets are standard assets whereas Non Performing assets are broadly further classified into Sub Standard Assets, Doubtful Assets and Loss Assets. Further Doubtful assets are also classified into three categories namely D1, D2, D3 assets.
Standard Asset is one which does not disclose any problems and which does not carry more than normal risk attached to the business. Such an asset should not be an NPA because here all the installments as well as interest are regularly paid.
With effect from March 31, 2005 an asset would be classified as substandard if it remained NPA for a period less than or equal to 12 months. In such cases, the current net worth of the borrowers / guarantors or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full. In other words, such assets will have well defined credit weaknesses that jeopardise the liquidation of the debt and are characterised by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected. An asset where the terms of the loan agreement regarding interest and principal have been re-negotiated or rescheduled after commencement of production, should be classified as substandard and should remain in such category for at least 12 months of satisfactory performance under the re-negotiated or rescheduled terms. In other words, the classification of an asset should not be upgraded merely as a result of rescheduling, unless there is satisfactory compliance of this condition.
With effect from March 31, 2005, an asset is required to be classified as doubtful, if it has remained NPA for more than 12 months. For Tier I banks, the 12-month period of classification of a substandard asset in doubtful category is effective from April 1, 2009. As in the case of sub-standard assets, rescheduling does not entitle the bank to upgrade the quality of an advance automatically. A loan classified as doubtful has all the weaknesses inherent as that classified as substandard, 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. An NPA need not go through the various stages of classification in case of serious credit impairment and such assets should be straightway classified as a doubtful / loss asset as appropriate. Erosion in the value of security can be reckoned as significant when the realizable 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.
A loss asset is one where loss has been identified by the bank or internal or external auditors or by the Co-operation Department or by the Reserve Bank of India inspection but the amount has not been written off, wholly or partly. 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 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 after obtaining necessary permission from the competent authority as per the Co-operative Societies Act / Rules, or fully provided for by the bank.
Broadly speaking, classification of assets into above categories should be done taking into account the degree of well defined credit weaknesses and extent of dependence on collateral security for realisation of dues. In respect of accounts where there are potential threats to recovery on account of erosion in the value of security and existence of other factors such as, frauds committed by borrowers, it will not be prudent for the banks to classify them first as substandard and then as doubtful after expiry of 12 months from the date the account has become NPA. Such accounts should be straight away classified as doubtful asset or loss asset, as appropriate, irrespective of the period for which it has remained as NPA.
When the amounts due to a bank (present value of principal and interest receivable as per restructured loan terms) are fully covered by the value of security, duly charged in its favour in respect of those dues, the bank’s dues are considered to be fully secured. While assessing the realisable value of security, primary as well as collateral securities would be reckoned, provided such securities are tangible securities and are not in intangible form like guarantee etc., of the promoter / others. However, for this purpose the bank guarantees, State Government Guarantees and Central Government Guarantees will be treated on par with tangible security.
REQUIREMENT OF PROVISIONS ON STANDARD AND NPA ASSETS
Provisions are required to set aside a buffer to absorb likely losses. In the fortunate case if the loss does not occur, the provisions may be written back to the Profit and Loss account. But in the unfortunate case, if the loss occurs, the bank does not have to suddenly declare a huge loss. The bank can use the provisions made to set off the losses due to NPAs. In this way it helps to present a True and Fair picture of the Bank’s Balance Sheet.
PROVISIONS FOR STANDARD ASSETS
For urban coop banks the general provisioning requirement for all types of ‘standard advances’ shall be 0.40 per cent. However, direct advances to agricultural and SME sectors which are standard assets, would attract a uniform provisioning requirement of 0.25 per cent of the funded outstanding on a portfolio basis, as hitherto.
Further, with effect from Dec 8, 2009, all UCBs (Both Tier I & Tier II) are required to make a provision of 1.00 percent in respect of advances to the Commercial Real Estate Sector classified as ‘standard assets’. For, Commercial Real Estate Residential Housing Sector (CRERH) 0.75 percent provision should be made.
For commercial banks direct advances to agricultural and Small and Micro Enterprises (SMEs) sectors at 0.25 per cent; advances to Commercial Real Estate (CRE) Sector at 1.00 per cent; Commercial Real Estate Residential Housing Sector (CRERH) 0.75 percent, all other loans and advances not included in (a) (b) and (c) above at 0.40 per cent.
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 Schedule 5 of the balance sheet.
PROVISIONS FOR SUB STANDARD ASSETS
For urban coop banks a general provision of 10 per cent on total outstanding should be made without making any allowance for DICGC / ECGC guarantee cover and securities available.
For commercial banks a general provision of 15 percent on total outstanding should be made without making any allowance for ECGC guarantee cover and securities available. The ‘unsecured exposures’ which are identified as ‘substandard’ would attract an additional provision of 10 per cent, i.e., a total of 25 per cent on the outstanding balance. However, in view of certain safeguards such as escrow accounts available in respect of infrastructure lending, infrastructure loan accounts which are classified as substandard will attract a provisioning of 20 per cent instead of the aforesaid prescription of 25 percent.
PROVISIONS FOR DOUBTFUL ASSETS
For coop banks Provision should be for 100 per cent 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 should be made and the realisable value is estimated on a realistic basis. For secured portions 20%, 30% and 100% for D1,D2,D3 category respectively. (D1 = doubtful up to 1 year, D2= doubtful 1 to 3 years, and D3= doubtful more than 3 years).
For commercial banks 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. For secured portions 25%, 40% and 100% for D1,D2,D3 category respectively. (D1 = doubtful up to 1 year, D2= doubtful 1 to 3 years, and D3= doubtful more than 3 years).
PROVISIONS FOR 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.
The regulatory norms for provisioning represent the minimum requirement. A bank may voluntarily make specific provisions for advances at rates which are higher than the rates prescribed under existing regulations, to provide for estimated actual loss in collectible amount, provided such higher rates are approved by the Board of Directors and consistently adopted from year to year. Such additional provisions are not to be considered as floating provisions. The additional provisions for NPAs, like the minimum regulatory provision on NPAs, may be netted off from gross NPAs to arrive at the net NPAs. The bank’s board of directors should lay down approved policy regarding the level to which the floating provisions can be created. The bank should hold floating provisions for ‘advances’ and ‘investments’ separately and the guidelines prescribed will be applicable to floating provisions held for both ‘advances’ & ‘investment’ portfolios. Floating provisions cannot be reversed by credit to the profit and loss account. They can only be utilised for making specific provisions in extraordinary circumstances. Until such utilisation, these provisions can be netted off from gross NPAs to arrive at disclosure of net NPAs. Alternatively, they can be treated as part of Tier II capital within the overall ceiling of 1.25 % of total risk weighted assets.
In some cases considering the demand of the situation, Reserve Bank of India may ask the lending institutions to make extra provision on the Loan Assets. RBI has issued special guidelines for special extra provisions in cases of Special scheme for Restructure of advances to MSME sector and in case of Special Moratorium Relief due to Covid-19.
REQUIREMENT OF EFFECTIVE MECHANISM
Asset quality of banks is one of the most important indicators of their financial health. Banks should, therefore, put in place a robust MIS mechanism for early detection of signs of distress at individual account level as well as at segment level (asset class, industry, geographic, size, etc.). Such early warning signals should be used for putting in place an effective preventive asset quality management framework, including a transparent restructuring mechanism for viable accounts under distress within the prevailing regulatory framework, for preserving the economic value of those entities in all segments. The banks’ IT and MIS system should be robust and able to generate reliable and quality information with regard to their asset quality for effective decision making. There should be no inconsistencies between information furnished under regulatory / statutory reporting and the banks’ own MIS reporting. Banks should also have system generated segment wise information on non-performing assets and restructured assets which may include data on the opening balances, additions, reductions (upgradations, actual recoveries, write-offs etc.), closing balances, provisions held, technical write-offs, etc.