MANAGEMENT OF NPA

OBJECTIVES

The identification of NPA and provisioning requirements. the accounting part of NPA accounts when recovery is made and provisions are made. The aim is also to get familiarized with RBI guidelines about NPA.

INTRODUCTION

NPA has become a very vital area for any bank. Turning account as NPA erodes the profit and at a subsequent stage, if not controlled, the capital also. In awarding gradation to the banks by RBI and the statutory auditors, NPA is the most important determining factor. As per RBI guidelines, asset classification and provisioning is required to be done correctly.

INCOME RECOGNITION, ASSET CLASSIFICATION AND PROVISIONING

Preliminary

1. In order to reflect Bank's actual financial health in its balance sheet and as per recommendations made by the Narsinmhan Committee the RBI has introduced prudential norms for,

(a) income recognition, asset classification and provisioning for the advances and investment portfolio and

(b) valuation of foreign exchange transactions.

2. The policy of income recognition is based on the record of recovery. This objective criterion is to be applied to all the loan accounts and asset accounts consistently and uniformly. Availability of security or net-worth of the borrower/guarantor should not be taken into account for the purpose of creating an advance as a non-performing asset. RBI has further advised that if the applicable Co-operative Societies Act and/or rules made thereunder or any other applicable statutory provisions are more stringent than prescribed by RBI, they shall continue to be applicable.

3. The Reserve Bank of India is giving guidelines on this subject to the Co-operative Banks from time to time by issuing circulars. The different norms and procedural instructions get changed from time to time. Therefore, consolidating all the instructions RBI has issued a master circular on NPA on 1st July 2008 (UBD.PCB.MC No. 3). These circulars get constant modifications and readers must see the updated circulars.

Classification of Asset as Non-Performing Assets (NPA)

An asset becomes non-performing when it ceases to generate income for the Bank. Earlier an asset was considered as Non-Performing Asset (NPA) based on the concept of 'Past Due'. However, with effect from March 31, 2001, the concept of 'Past Due' has been changed. Now from that date, a Non-Performing Asset (NPA) is an advance, where:

(i) Interest and/or installment of principal remain overdue for a period of more then 90 days in respect of a Term Loan.

(ii) The account remains 'out of order' for a period of more than 90 days, in respect of any type of working capital.

(iii) The bill remains overdue for a period of more than 90 days in case of bills purchased and discounted.

(iv) Interest and/or installment of principal remain overdue for two harvest seasons but for a period not exceeding two half years in case of agricultural advances specified to be for that purpose. These advances are detailed hereinbelow. For non-specified agricultural advances the identification of NPA is to be done on the same basis as non-agricultural advances.

(v) Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.

The specified agricultural advances referred at point No. (iv) are,

(a) Direct finance to farmers for agricultural purposes.

(i) This includes term loans for raising crops i.e. crop loans. Additionally, advances up to Rs. 1.00 lac to farmers against pledge/hypothecation of agricultural produce including warehouse receipt for such products for a period not exceeding six months and such loan is given for raising crop and loan is availed only from one bank.

(ii) Medium and long-term loans given directly to the farmers for financing production and development needs.

(b) Purchase of agricultural implements and machinery such as.

(i) iron ploughs, harrows, hose, land-levellers, bund-formers, hand tools, sprayers, dusters, hay-press, sugarcane crushers, thresher machines etc.

(ii) tractors, trailers, power tillers, tractor accessories like disc ploughs etc.

(iii) trucks, mini-trucks, jeeps, pick-up vans, bullock carts and other transport equipments etc. to assist the transport of agricultural inputs and farm products.

(iv) plough animals.

(c) Loans for the development of irrigation potential.

(i) Construction of shallow and deep tube wells, tanks digging etc. and purchase of drilling unit.

(ii) Construction and deepening and clearing of surface wells, boring of wells, electrification of wells, purchase of oil engines and installation of electric motor and pumps.

(iii) Purchase and installation of turbine pumps, construction of open or underground field channels.

(iv) Construction of lift irrigation project.

(v) Installation of sprinkler irrigation system.

(vi) Purchase of generator sets for energization of pump-sets used for agricultural purposes.

(d) Reclamation and Land Development Schemes.

(i) Bunding and levelling of farmland, terracing, development of irrigable land, wasteland development, development of farm drainage, reclamation of soil land, prevention of salinization, purchase of bulldozers etc.

(e) Construction of farm building and structure.

(i) Bullock sheds, implement sheds, tractor and truck sheds, farm stores, etc.

(f) Construction and running of storage facilities.

(i) Construction and running of warehouses, godowns and loans granted to farmers for establishing cold storage used for storing own produce.

(g) Production and processing of hybrid seeds for crops.

(h) Payment of irrigation charges etc.

(i) Payment of hired water charges from wells and tube wells, canal water charges.

(ii) Maintenance and upkeep of oil engines and electric motors.

(iii) Payment of labour charges, electricity charges, marketing charges, service charges to customers service units, payment of development cess etc.

(i) Other types of direct loans to farmers.

(i) Short term loans for traditional and non-traditional plantations and horticulture.

(ii) Medium and Long Term loans for the development of all plantations, horticulture, forestry and wasteland.

Identification of NPA as Ongoing Process.

1. Banks are required to evolve a system that ensures identification of NPA is done on an on-going basis and doubts in asset classification due to any reason, are settled through specified internal channels within one month from the date on which the account would have been classified as NPA as per prescribed norms.

 2. Banks are required to chalk out an appropriate transition path for smoothly moving over the 90 days norms.

Charging of Interest at Monthly Rests

(i) Banks are required to charge interest at monthly rests in the context of adopting 90 days norms for recognition of NPA from the year ending 31' March 2004.

(ii) The existing practice of charging and compounding of interest on agricultural advances would be linked to crop seasons and the instructions regarding charging of interest on monthly rests shall not be applicable to agricultural advances.

(iii) For short duration crop loans and allied agricultural activities, Banks need to keep in mind due dates of the advances on the basis of liquidity with the borrowers keeping in mind harvesting/marketing season.

Out of Order 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 the cover the interest debited during the same period, these accounts should be treated as 'out of order'.

Treatment of Accounts as NPA

A. Record of Recovery

(a) The treatment of an asset as NPA should be based on the record of recovery. Banks should not treat the account as NPA merely due to the existence of some deficiencies, which are of temporary nature such as occasional non-availability of adequate drawing power, balance outstanding exceeding the limit, non-submission of stock statements, non-renewal of limits on a due date etc. However, the asset should be treated as NPA where there is a threat of loss or the recoverability of the advance is in doubt.

(b) If the account classified as NPA is regularized by repayment of overdue amounts through genuine sources, and not by the sanction of additional facilities or transfer of funds between accounts, the account need not be then treated as NPA. In such cases, however, it has to be ensured that the account remains in order subsequently and a solitary credit entry which recovers the overdue amount of interest or installment is not taken into account as the sole criteria for treating the account as a standard asset.

B. Treatment of NPA - Borrower wise or Facility wise

(i) If the borrower has more than one facility with a bank and if only one or more particular facility or facilities become irregular and NPA, then that borrower's all facilities with the bank are required to be declared as NPA and not that particular .one which has been classified as NPA.

(ii) In case of consortium advance or finance under multiple banking arrangements, each the bank may classify the borrowal account according to its own record of recovery and other aspects having bearing on the recovery.

(iii) Where natural calamities disturb the repaying capacity of agricultural borrowers, banks may on their own decisions, as a relief measure, to convert the short-term production loan into a term loan or re-schedule the repayment period and can also sanction fresh short-term loans. In such case, the converted or re-scheduled loan need not be classified as NPA

Housing Loan to Staff

In case of housing loan or similar loan granted to staff members of the Bank where interest is payable after recovery of principal, the interest is not to be considered as overdue. If the principal or interest is not recovered on due dates, then only the account will be treated as NPA.

Credit Facilities guaranteed by Govt. of India/State Govts.

(i) The credit facilities backed by a guarantee of the Central Government though overdue should not be treated as NPA.

(ii) However, the above exemption is for classification of NPA, but un-recovered interest on such advance is not to be considered as income while considering income recognition on the advances.

(iii) Advances sanctioned against State Govt. guarantee need to be classified as NPA in usual applicable norms for that advances.

Project Finance with Moratorium for Payment/re-Payment

When the advance is given allowing moratorium for payment of interest, the interest becomes due after the moratorium or gestation period is over. So while applying NPA norms, moratorium period is to be excluded.

Other Advances

1. Advances against term deposits, NSCs eligible for surrender, Indira Vikas Patra, Kisan Vikas Patra and Life policies assigned to the bank are not required to be classified as NPA even though interest thereon is not paid for more than 90 days provided adequate margin is available in the accounts.

2. For gold loans for non-agriculture purposes, banks have to fix monthly/quarterly installments for repayment of loan taking into account the pattern of income generation and repayment capacity of the borrower. Thereafter, the gold loans are to be classified as NPA or otherwise applying usual norms of overdue concept.

3. As regards gold loans granted for agricultural purposes, interest is required to be charged on a yearly basis and repayment has to coincide with the harvesting of crops. Accordingly, due date and overdue concepts are to be applied in usual way.

Recognition of Income on Investment Treated as NPA

The investments made by the bank, are also subject to the prudential norms on income recognition. Bank cannot book income on an 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.

NPA Reporting to Reserve Bank of India

The Co-operative Banks are required to report the figures of NPAs to the RBI at the end of each year within two months from the close of the year in the prescribed format.

ASSET CLASSIFICATION

A. Classification

The Primary Urban Co-operative Banks are required to classify their assets into the four categories:

(i) Standard Assets

(ii) Sub-standard Assets

(iii) Doubtful Assets

(iv) Loss Assets

B. Definitions

I. Standard Asset

(i) Standard Asset is one that does not disclose any problems and which does not carry more than normal risk attached to the business. Such an asset should not be NPA.

II. Sub-Standard Asset

(i) Sub-Standard Asset is one that has remained as NPA for a period less than or equal to 12 months.

(ii) In case of Sub-Standard asset, 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 Bank in full. As such, these assets bear a credit weakness that can jeopardize the liquidation of the debt. In these cases, there is a clear possibility that the Bank will sustain a loss if the deficiencies are not corrected in time.

(iii) In case of loans where the terms of loan agreement regarding interest and the principal has been re-negotiated or re-scheduled after commencement of production, such loan accounts are required to be classified as Sub-Standard and should remain in such category for at least 12 months of satisfactory performance under re-negotiated or re-scheduled terms. Thus, the classification of the advance should not be immediately upgraded merely as a result of re-scheduling.

III. Doubtful Asset

(i) An asset is required to be classified as doubtful if it has remained in the sub-standard category for 12 months. As in the case of Sub-Standard assets, re-scheduling does not entitle the bank to upgrade the quality of an advance automatically.

(ii) A loan classified as doubtful has all the weaknesses as they are in Sub-Standard asset but it has added characteristic that the weaknesses make the realization of banks dues highly questionable and improbable.

IV. Loss Asset

A loss of an 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 RBI inspection but the amount has not been written off, wholly or partly. Such asset is considered as un-collectible and of such little asset value that its continuation as a bankable asset is not warranted although there may be some salvage or recovery value.

GUIDELINES FOR CLASSIFICATION OF ASSETS

Basic Consideration

(i) Classification of assets into above stated four categories has to be done taking into account the degree of well-defined credit weaknesses and extent of dependence on collateral security for the realization of Bank's dues.

(ii) In case of accounts where there are potential threats in recovery on account of erosion in the value of security and the existence of other factors such as fraud committed by the borrower, it will not be prudent for the bank to classify the advance first as Sub-Standard and then as the as doubtful and then as loss asset observing the prescribed periods of 12 months. Such accounts can be straight away classified as a doubtful asset or loss asset, as is appropriate, irrespective of the period for which it has remained as NPA.

Advance Granted Under Rehabilitation Packages Approved by BIFR/Term Lending Institutions

(i) If for any unit, if the loan facilities are already classified as sub-standard or doubtful, any additional facilities sanctioned under the rehabilitation package, the old facilities will continue as it is for classification purposes. Merely on reason, that rehabilitation package is sanctioned the loan asset quality will not improve or get up-graded. For the additional facilities granted under the package, the Income Recognition and Asset Classification norms will become applicable after one year from the date of disbursement of additional facilities.

(ii) Similar relaxation of one year is applicable in respect of SSI units, which are identified as sick by banks themselves and where rehabilitation package/nursing programmes have been drawn by the banks themselves or under consortium arrangements.

Internal System for Classification of Assets as NPA

1. Banks are required to establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of NPAs, especially in respect of high-value accounts. The banks may fix a minimum cut-off point to decide what would constitute a high-value account depending upon their respective business levels. The cutoff point should be valid for the entire accounting year.

2. Banks are required to fix responsibility and validation levels for ensuring proper asset classification.

3. There should be a system to ensure that doubts in asset classification due to any reason are settled through specified internal channels within one month from the date on which the account would have been classified as NPA as per the extant guidelines.

4. RBI has the powers and function to identify cases of non-observance of Income Recognition and Asset Classification due to non-compliance and for fixing accountability. Where there is willful non-compliance by the official responsible for the classification and it is well documented, RBI can initiate deterrent action including imposition of monetary penalties.

INCOME RECOGNITION

(i) The policy of income recognition has to be objective and based on the record of recovery. Income from non-performing assets is not to be recognized on an accrual basis but is to be booked as income only when it is actually received.

(ii) However, interest on advances against term deposits, NSCs, IVPs, KVPs and Life Policies can be taken to income account on the due date, provided adequate margin is available in the accounts.

(iii) Fees and commissions earned by the banks as a result of re-negotiations or rescheduling of outstanding debts are required to be recognized on an accrual basis over the period of time covered by the renegotiated or rescheduled extension of credit.

(iv) If Government guaranteed advances become `overdue' and thereby NPA, the interest on such advances cannot be taken to income account unless the interest has been realized. The exemption granted for the purpose of asset classification detailed hereinabove is only for classification purposes and not for income recognition.

Reversal of Income on Account becoming NPA

If any advance including bills purchased and discounted becomes NPA as at the close of any year, interest accrued and credited to income account in the corresponding the previous year needs to be reversed or provided for if the same is not realized. This will apply to Government guaranteed accounts also.

Booking of Income on Investments in Shares and Bonds

(i) As a prudent practice and in order to bring about uniform accounting practice among banks in the booking of income on units of UTI and equity of All India Financial Institutions, such income has to be booked on a receipt basis and not on accrual basis.

(ii) However, in respect of income from Govt. securities/bonds of the public sector undertakings and All India Financial Institutions, where interest rates on the instruments are predetermined, income may be booked on an accrual basis, provided interest is serviced regularly and is not in arrears.

Partial Recovery in NPA

Interest realized on NPA may be taken to income account provided the credits in the accounts towards interest are not out of fresh/additional credit facilities sanctioned to the borrower concerned.

Interest Application

(i) In case of NPAs where interest has not been received for 90 days or more, as a prudential norm, there is no use in debiting/charging the said account as interest is not being received. It is simultaneously desirable to show such accrued interest separately or park in a separate account so that interest receivable on such NPA account is computed and shown as such, though not accounted as income of the Bank for the period.

(ii) The interest accrued in respect of performing assets may be taken to the income account as the interest is reasonably expected to be received. However, if interest is not actually received for any reason in these cases and the account is to be treated as NPA as per the guidelines, then the amount of interest so taken to income has been reversed or should be provided for in full.

(iii) With a view to ensuring uniformity in accounting the accrued interest in respect of both the performing and non-performing assets, the following guidelines may be adopted by the banks notwithstanding the existing provisions in the respective State Co-operative Societies Act:

(a) Interest accrued in respect of non-performing advances should not be debited to borrowal accounts but shown separately under 'Interest Receivable Account' on the 'Property and Assets' side of the balance-sheet and corresponding amount shown under 'Overdue Interest Reserve Account' on the 'Capital and Liabilities' side of the balance sheet.

(b) In respect of borrowal accounts, which are treated as performing assets, accrued interest can be debited to the borrowal account and credited to Interest Account and taken to an income account. In such case, if interest is not actually received before the end of the accounting year viz. 31St March or the account needs to be treated as NPA as per the guidelines, the equivalent amount corresponding to such unrealized interest should be reversed by debit to profit and loss account and credited to 'Overdue Interest Reserve' Account.

PROVISIONING NORMS

Norms for Provisioning on Loans and Advances

(i) In conformity with the prudential norms, provisions are required to be made on the non-performing assets on the basis of classification of assets into prescribed categories as detailed above,

(ii) Taking into account the time lag between an account becoming doubtful of recovery, its recognition as such the realization of the security and erosion overtime in the value of security charged to the bank, the banks have to make provisions against loss assets, doubtful assets and sub-standard assets as below:

(a) Loss Assets

1. The entire assets should be written off after obtaining necessary approval from the competent authority and as per the provisions of the applicable 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.

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

(b) Doubtful Assets

1. 100 per cent 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 should be made. The realizable value is to be estimated on a realistic basis.

2. In regard to the secured portion, provision may be made on the following basis, at the rates ranging from 20% to 100 % of the secured portion depending upon the period for which the asset has remained doubtful.

* The percentage is dependant on the date of classification as doubtful and different percentages have been prescribed by RBI for Tier — I banks and Tier—II banks. It should be noted that for accounts remaining in the doubtful category for more than three years, 100% provision will be required from 31/03/2013 for Tier — I banks and from 31/03/2010 for Tire — II banks.

(iii) Sub-Standard Asset

1. A general provision of 10% on total outstanding needs to be done, without considering DICGC/ ECGC guarantee cover and securities available.

Provision on Standard Asset

(i) Banks have to make a general provision of a minimum of 0.40 per cent on Standard Asset.

(ii) The provision made has to be shown separately as "Contingent Provision against Standard Assets" under "Other Funds and Reserves" in the Balance sheet.

(iii) The provision made for Standard Asset is eligible for inclusion in Tier-II capital.

Higher Provision

Banks can make higher provisions for bad and doubtful debts reserve (BDDR) than prescribed by RBI either on their own or if provided in the respective State Co-operative Acts.

Provision for advances against some specific securities.

(a) Advances against Term Deposits, NSCs eligible for surrender, IVPs, KVPs and life policies are exempted from provisioning requirements.

(b) Advances against gold ornaments, Govt. securities and all kinds of such securities are not exempt from provisioning requirements.

ASSET CLASSIFICATION IMPLEMENTATION

(a) Banks are bound to ensure scrupulously compliance with the instructions for recognition of credit impairment and view aberration seriously.

(b) Banks are bound to establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of NPAs, especially in respect of high-value accounts. Banks are required to fix a minimum cut off point to decide what would constitute a high-value account depending upon their respective levels. The cutoff point once decided should be valid for one year.

(c) The responsibility and validation levels for ensuring proper asset classification maybe fixed by the banks.

(d) Where there is willful non-compliance by the officials responsible for classification and the same is well documented, RBI can initiate deterrent action including imposition of monetary penalties.