Income Recognition and Asset Classification (IRAC) Norms
Thus, one needs to be well versed with the regulatory guidelines related to Income Recognition, Asset Classification and Provisioning, besides being equally envisage about the accounting aspects related thereto.
Foundations of IRAC Norms & Mandatory Automated Systems
The classification of assets of banks has to be done on the basis of objective criteria, which would ensure a uniform and consistent application of the norms. The provisioning should be made on the basis of the classification of assets based on the period for which the asset has remained non-performing and the availability of security and the realisable value thereof.
RBI Mandate on System-Based Asset Classification (June 30, 2021 Deadline):
The Reserve Bank of India directed the banks to ensure the completeness and integrity of the automated Asset Classification (classification of advances/investments as NPA/NPI and their upgradation), Provisioning calculation and Income Recognition Processes, advised the banks to put in place / upgrade their systems to conform to the guidelines latest by June 30, 2021. The System based asset classification is expected to be an ongoing exercise for both down-gradation and up-gradation of accounts and is required to be made part of day end process, whereby classification status report can be generated through system at any given point of time with actual date of classification of assets as NPAs/NPIs.
RBI has issued Master Circular on Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances on April 01, 2022 consolidating instructions on the said matters issued upto March 31, 2022.
Objective Criteria for Classification of Advances Across Facility Types
The RBI has defined various objective criteria as regards classification of advances across credit facility types:
1. Term Loans: Overdue Mechanics & Repayment Calendar
> 90 Days OverdueA Term Loan is classified as NPA if Interest and/or installment remains overdue for a period of more than 90 days. The exception to the above criteria would be Term Loans with moratorium period granted for interest as well as principal wherein the interest would be accrued and due only after the completion of the moratorium period.
Thus, it is vital to understand the meaning of the term ‘overdue’. The Master Circular defines ‘Overdue’ – ‘If an amount due to bank under any credit facility is not paid on the due date fixed by the bank, such amount would be called as Overdue.’ The exact due dates for repayment of a loan, frequency of repayment, breakup between principal and interest are required to be clearly specified in the loan agreement and the borrower should be apprised of the same at the time of loan sanction and also at the time of subsequent changes, if any, to the sanction terms/loan agreement till full repayment of the loan.
Accordingly, a Term Loan borrower is provided with a repayment calendar which contains the above referred details and an inference of ideal outstanding balance as on any date can be drawn by referring to such repayment calendar. Thus, amount overdue for a term loan is nothing but an adverse difference between the amount demanded by (due to) the bank (which is EMI plus any other amount as per the terms of sanction) and amount received from the borrower. In other words, overdue amount as on a particular date is an adverse difference between ideal drawing power (i.e., ideal balance in term loan account if the repayment is made exactly on the respective due dates) and ledger balance as on that date.
- Additional Interest for delayed repayment: which arises due to delay in payment of the predefined repayment amount.
- Penal Interest levied on the overdue amount: as per terms of sanction.
These additional amounts are immediately due as and when are debited in the term loan account (and not at the end of tenor of the term loan) and are required to be paid by the borrower in addition to the predefined repayment amounts. If unpaid, they qualify as ‘overdue’. Thus, the simple yardstick to analyse if an account has an amount which is overdue is to verify if there is an adverse difference between ideal drawing power and ledger balance (ledger balance being more than ideal drawing power as on a cut-off date).
- Treatment (i): Bank does not credit advance received in the Term Loan account and parks the same under the head ‘Other Liabilities’ and recovers the instalments / EMI therefrom on respective due dates, or,
- Treatment (ii): Bank credits the said amount to the credit of the Term Loan account and either the remaining tenor of the loan is reduced and / or subsequent EMI is reduced accordingly, or,
- Treatment (iii): Bank considers that such prepayments do not amount to change in subsequent EMI amounts and / or tenor of loan and are thus, adjusted against the outstanding balance in Term Loan accounts immediately on the date such amounts are received, thereby the borrower being benefitted with reduced interest due to reduction in balance outstanding in Term Loan Account.
2. Bills Purchased / Discounted
> 90 Days OverdueIf such Bill remains overdue for a period of more than 90 days.
3. Agricultural Advances: Crop Season Framework
Crop SeasonsIf Interest or installment remains overdue for:
- Short Duration Crop: Two crop seasons.
- Long Duration Crop: One crop season (where crop season is more than 12 months).
A crop season is defined as ‘period up to harvesting of crops raised’ as determined by State Level Bankers’ Committee (SLBC).
4. Derivative Transactions
Overdue receivables representing positive mark-to-market value of a derivative contract remaining unpaid for a period of 90 days from specified due date.
5. Liquidity Facility
If it remains outstanding for more than 90 days in respect of a Securitization transaction.
6. Credit Card Dues
If the minimum amount payable is not paid fully within 90 days from the next statement date.
7. Cash Credit / Overdraft (CC/OD): ‘Out of Order’ Norms
Out of OrderA CC/OD account is treated as NPA if the same is ‘Out of Order’. The account is called as out of order if any one of the following conditions is fulfilled:
Condition (b): No credit continuously for 90 days; or, credits in the account are not enough to cover interest debited during the previous 90 days.
Statutory Clarifications & Exceptions to IRAC Norms
The RBI has clarified specific exceptions, special circumstances, and detailed procedures:
1. Non-submission / Non-availability of Stock Statement:
Outstanding Balance in account based on the drawing power calculated from stock statements older than 3 months would be deemed as irregular and if such irregular drawing is permitted for a period of more than 90 days, account needs to be classified as NPA. However, it would be pertinent to note that the relaxation so given by RBI is ‘considering the difficulties of large borrowers’, thus, limiting its applicability to large borrowers only and thus should not be construed as generic.
2. Non-renewal / Non-regularization of Regular / Adhoc Limit:
If the review/renewal of regular or ad-hoc limit is not done within 180 days from the due date, the account would be classified as NPA.
3. Advances Against Term Deposits, NSCs, IVPs, KVPs & Life Insurance Policies:
Need not be treated as NPAs, till security cover is sufficient to cover outstanding balance, provided Income is recognized subject to availability of margin.
4. Central Government Guaranteed Advances:
Classified as NPA only if Central Government repudiates the guarantee when invoked. However, income from such accounts is required to be recognized on ‘Cash’ (realization) basis.
5. LCBD Facilities (Letter of Credit Backed Discounting):
The Bill discounted against accepted LC would be treated as Performing Asset (PA) even though rest of the facilities of the borrower are treated as NPA (since the exposure of the bank in such cases would be on the LC issuing bank and not on the borrower), except in the instances wherein the LC issuing bank is itself.
6. Consortium Banking Arrangements:
Each member bank shall classify the accounts according to their own record of recovery.
7. Potential Threat of Recovery (Straightway Classification):
- Doubtful Asset Straightaway: Where realisable value of security is less than 50% of the value assessed (by bank or value accepted in last RBI Inspection).
- Loss Asset Straightaway: Where realisable value (as assessed by Bank / Valuator / RBI Inspector) of security is less than 10% of the outstanding balance.
8. Fraud Accounts Provisioning:
In case of Fraud Accounts, 100% provision is to be made irrespective of security, spread over 4 quarters commencing from the quarter in which fraud has been detected wherein the same is reported to RBI. In cases wherein the fraud cases are not reported to RBI, 100% to be provided instantly.
9. Solitary or Few Credit Entries Recorded Before Balance Sheet Date:
If the account is exhibiting signs of inherent weakness, such account is required to be marked as NPA. In other cases, the bank needs to evidence the auditors about manner of regularisation of account; in absence of such evidence, such accounts should be marked as NPA. Regularisation of the account either at year-end or otherwise needs to be out of genuine sources of funds, such as from income generating activities of the borrower and not by way of availing additional credit facilities / loans either from the bank or any other resources to regularize existent credit facilities.
10. Mandatory Valuation of Securities in NPAs:
In case of NPAs wherein the outstanding balance is more than Rs. 5 crores, it is mandatory to conduct stock audit by external agencies. As regards immovable properties taken as securities, the valuation is required to be carried out at least once in three years by approved valuer. As regards other securities, auditors need to verify appropriateness in valuation methodology and consistency.
11. Regularisation & Upgradation of Accounts (Partial Regularisation & Post Balance Sheet Date):
In case if an account is a NPA, irrespective of whether the account is marked by the bank as NPA or not, the upgradation of the account would be subject to the condition that the entire arrears of interest and principal are recovered (in case of Term Loan Accounts) or the working capital accounts are regularised out of genuine business credits.
The regularisation of the account subsequent to the Balance Sheet date does not affect the assets classification as the upgradation of the account would be effected only prospectively on the date of regularisation. Further, regularisation of the account by ensuring repayment of entire arrears needs to be at borrower level, and not at account level.
Project Loans: DCCO Deferment, Restructuring & Asset Classification
The change in repayment schedule is permitted without change in asset classification if the same is caused due to increase in project outlay on account of increase in scope and size of the project, subject conditions stipulated in Para 4.2.15.6.2 of the Master Circular.
The usual classification norms apply before the commencement of commercial operations. However, in case of accounts wherein the borrower fails to commence commercial operations within two years and within one year from the date of commencement of commercial operations (DCCO) w.r.t. Infrastructure and non-infrastructure sectors respectively, the account needs to be classified as NPA, unless eligible to be restructured and classified as standard asset.
| Particulars | Infrastructure Sector | Non-Infrastructure Sector |
|---|---|---|
| Revised DCCO is within | Two years from original DCCO | One year from original DCCO |
| Revision due to Court Case | 2 + 2 Years from original DCCO | 1 + 1 Years from original DCCO |
| Revision due to any other reasons beyond control of promoters | 2 + 1 Years from original DCCO | 1 + 1 Years from original DCCO |
Income Recognition & Mandatory Reversal of Unrealised Income
The income on Standard Assets is recognised on Accrual basis and the same on NPAs is recognised on Cash (realisation) basis.
“If any advance, including bills purchased and discounted, becomes NPA, the entire interest accrued and credited to income account in the past periods, should be reversed if the same is not realised. This will apply to Government guaranteed accounts also. Similarly, in respect of NPAs, fees, commission and similar income that have accrued should cease to accrue in the current period and should be reversed with respect to past periods, if uncollected.”
‘Cover’ vs. ‘Realisation’ Distinctions in Automated Core Banking:
It would be significant to note that reversal of income is required to be applied once an account is marked as NPA to the extent of income and fees / commission, etc., which has remained unrealised. Thus, the concept of ‘unrealised’ interest is applicable post an account being marked as NPA and does not form part of various criteria specified for classifying an account as NPA as per Para 2 of the Master Circular; e.g.:
- Distinction in CC/OD Accounts: The second criteria for treating a CC/OD account as ‘out of order’ is related to whether the credit summation in previous 90 days ‘cover’ the interest debited in the same period. Thus, the concept of ‘cover’ and ‘realisation’ are distinct and needs to be considered appropriately for respective purposes.
- Distinction in Term Loans: In case of a Term Loan, if an advance instalment received is credited to the loan ledger account, the same results in reduction in ledger balance and accordingly effects the calculation of ‘overdue amount’ but would not amount to realisation of interest debited to the said term loan account subsequently.
Similarly, in case of a Term Loan account, interest debited in the account cannot be said to be realised out of prior credits received in the account (whether as prepayment or otherwise).
Thus, to summarise, when an account is marked as NPA, the interest / fees / commission / bank charges debited to the account, which are not realised as on the date of NPA are required to derecognised and subsequently needs to be recognised on realisation basis. It would be preeminent for the auditor to review the behaviour of the software to ensure allegiance to the concept of realisation.
- Additional Finance in NPAs: Interest on additional finance in NPAs should be recognised on cash basis.
- Conversion into Equity / FITL: If interest due is converted into unlisted equity / FITL, the same should be fully provided for; if converted into a listed instrument, interest should be recognised to the extent of market value of such security on the date of conversion.
- Order of Recovery: In case of recoveries in NPAs, in the absence of clear agreement between the Bank and the Borrower, an appropriate policy to be followed in uniform and consistent manner as regards order of recovery of outstanding interest and principal amount.
Asset Classification Categories & Provisioning Requirements Matrix
| Type of NPA | Criteria | Secured Portion* Provision | Unsecured Portion Provision |
|---|---|---|---|
| Sub-Standard (SSA) | First 12 months from date of NPA | Secured SSA: 15%$ |
Unsecured SSA: 25% Infrastructure SSA: 20% |
| Doubtful – I (DA-I) | Subsequent one year after SSA | 25% | 100% |
| Doubtful – II (DA-II) | Subsequent two years after DA-I | 40% | 100% |
| Doubtful – III (DA-III) | After two years in DA-II | 100% | 100% |
| Loss Asset | Identified by the bank or internal or external auditors or by RBI Inspectors as wholly irrecoverable but the amount for which has not been written off | 100% | 100% |