Prudential Norms on Income Recognition and Asset Classification – Changes effective for 31.3.2022
Author is a member of the Institute of Chartered Accountants of India (ICAI). He can be reached at eboard@icai.in.
1. Key RBI Regulatory Framework & Master Circulars
Foundation RBI Notifications Effective for Audit Period 2021-22:
- RBI/2020-21/37 Ref. No. DoS.CO.PPG./SEC.03/11.01.005/2020-21 dated September 14, 2020: Automation of Income Recognition, Asset Classification and Provisioning processes in banks.
- RBI/2021-2022/104 DOR.No.STR.REC.55/21.04.048/2021-22 dated October 1, 2021: Master Circular – Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances.
- RBI/2021-2022/125 DOR.STR.REC.68/21.04.048/2021-22 dated November 12, 2021: Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances – Clarifications.
- RBI/2021-2022/158 DOR.STR.REC.85/21.04.048/2021-22 dated February 15, 2022: Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances – Clarifications.
2. Automation of IRAC Norms – Daily Reckoning of NPA Status
This should be the most important change in the IRAC norms going forward from the current year and hence the members are advised to familiarise themselves before the audit is taken up. As per the notification dated September 14, 2020, banks were required to put in place or upgrade their systems to conform to the guidelines in respect of automated Asset Classification (classification of advances and investments as NPA/NPI and their upgradation) latest by June 30, 2021.
Banks have submitted compliance reports to the RBI. It is understood that while automation is put in place generally, specific modules are still in progress; hence auditors approaching bank branch audits must initially confirm the exact extent to which automated STP rules are operational.
Universal Account Coverage
All borrowal accounts, including temporary overdrafts (TODs), irrespective of size, sector, or types of limits, must be covered in the automated IT-based system for asset classification, upgradation, and provisioning processes, alongside bank investments.
Systemic Provisioning & Reversals
Calculation of provisioning must be entirely system-based as per pre-set rules, value of security captured in the system, and regulatory guidelines. Income recognition and reversals on impaired assets (NPAs/NPIs) must be system-driven without manual intervention.
Straight Through Process (STP)
The system must handle both downgrade and upgrade of accounts through Straight Through Process (STP) without any manual intervention, executing continuous classification as part of the daily Day-End Process (EOD).
The Core Structural Shift:
The downgrading of borrower accounts as NPA and upgrading as standard asset is now a daily ongoing exercise executed during the day-end process, rather than an exercise carried out periodically as on the balance sheet date.
3. Term Loans: Daily SMA & NPA Stamping Mechanism
As a result of moving to daily identification of NPA, the RBI issued vital clarifications vide circular dated 12.11.2021. Borrower accounts shall be flagged as overdue by banks as part of their day-end processes for the due date. Similarly, classification of borrower accounts as Special Mention Account (SMA) as well as NPA shall be done as part of the day-end process for the relevant date, and the SMA or NPA classification date shall be the calendar date for which the day-end process is run.
Practical Demonstration of Daily Delinquency Trajectory
Example: If the due date of a loan account is March 31, 2021, and full dues are not received before the bank runs the day-end process for this date, the date of overdue shall be March 31, 2021.
- SMA-1 Tagging: If it continues to remain overdue, the account gets tagged as SMA-1 upon running the day-end process on April 30, 2021 (i.e. upon completion of 30 days of continuous overdue). The classification date for SMA-1 is April 30, 2021.
- SMA-2 Tagging: If the account continues to remain overdue, it gets tagged as SMA-2 upon running the day-end process on May 30, 2021 (60 days continuous overdue).
- NPA Classification: If it continues to remain overdue further, it gets classified as NPA upon running the day-end process on June 29, 2021 (completion of 90 days). (Refer paragraph 11.97 of Guidance Note on Audit of Banks 2022 edition).
Interest Overdues on Term Loans: Alignment with Monthly Rests
Previously, an account was classified as NPA only if the interest due and charged during any quarter was not serviced fully within 90 days from the end of that quarter. To fully align with the 90 days delinquency norm and the requirement to apply interest at monthly rests, the instructions are modified:
Loan agreements must explicitly specify repayment due dates, frequency, principal-interest breakup, and SMA/NPA classification examples. When banks run interest application on staggered dates during the month, the 90-day norm must be tracked from the exact date of debit.
4. Working Capital (CC/OD) Accounts: The New ‘Out of Order’ Rules
In Cash Credit / Overdraft accounts, an account was historically treated as ‘out of order’ only if there were no credits continuously for 90 days as on the balance sheet date, or if credits were insufficient to cover interest debited during that same period.
The Three Statutory Grounds for ‘Out of Order’ Determination:
- The outstanding balance in the CC/OD account remains continuously in excess of the sanctioned limit/drawing power for 90 days, OR
- The outstanding balance is less than the sanctioned limit/drawing power, but there are no credits continuously for 90 days, OR
- The outstanding balance is less than the sanctioned limit/drawing power, but credits are not enough to cover the interest debited during the previous 90 days period.
Practical Comparative Contrast:
Hitherto: If balance exceeded Drawing Power from 15th December, an inflow received on 31st March restored standard status. Similarly, zero credits during December, January, and February cured by an inflow in late March kept the account standard.
Under Revised Norms: The account turns NPA by the end of the day on 14th March (being the end of the 90th day), and subsequent credit on 31st March cannot automatically undo NPA tagging unless full arrears are cleared.
RBI Clarifications dated 15.2.2022 on Special Overdraft Products:
Banks have introduced diverse OD products (e.g. Loans Against Property, personal guarantees) without stock statements, drawing power computations, or fund monitoring, where borrowers only service monthly interest. Doubts arose on whether revised norms applied. The RBI clarified:
- The definition of ‘out of order’ applies universally to all loan products offered as an overdraft facility, including non-business overdrafts and those entailing interest repayments as the only credits.
- The ‘previous 90 days period’ for determining ‘out of order’ status shall be inclusive of the day for which the day-end process is being run.
5. Securitisation Exposures & Agricultural Advances
Securitisation Liquidity Facilities
Under the Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021 dated 24.9.2021, securitisation redistributes credit risk into tradeable securities.
Agricultural Crop Loans
Classification is based on crop duration determined by the State Level Bankers’ Committee (SLBC) in each State:
- Short duration crops: Overdue for two crop seasons.
- Long duration crops: Overdue for one crop season.
Applies strictly to Farm Credit in Annexure-2 of Master Circular dated 1.10.2021. All other agricultural loans follow standard 90-day delinquency. (Refer paragraph 11.101 of Guidance Note 2022).
6. Upgradation of NPA Accounts: The Strict ‘Entire Arrears’ Mandate
Due to the percolator effect, once one credit facility of a borrower is classified as NPA, all other facilities granted to the same borrower must also be treated as NPA, even if the other facilities are in standard or SMA status.
Prohibition of Upgradation on Partial Recovery
The RBI observed that lending institutions were upgrading NPAs to ‘standard’ upon receipt of only partial overdues or interest arrears. The circular dated 12.11.2021 and 15.2.2022 firmly mandates:
“In case of borrowers having more than one credit facility from a lending institution, loan accounts shall be upgraded from NPA to standard asset category only upon repayment of entire arrears of interest and principal pertaining to all the credit facilities.”
Multi-Facility Upgradation Example:
If a borrower has a Term Loan classified as NPA and a Home Loan that was standard, the Home Loan is also classified as NPA. If the Term Loan irregularity is completely removed but the Home Loan slips into SMA, the borrower continues to be classified as NPA across all facilities until the Home Loan also moves from SMA to Standard with zero overdues. (Refer paragraph 11.135(i) and Page 396 of Guidance Note on Audit of Banks 2022).
7. Interest Moratorium, Appropriation Policy & Intangible Collateral
Interest Accrual During Moratorium & COVID FITL
Where interest repayment moratorium is granted under the Prudential Framework for Resolution of Stressed Assets (June 7, 2019), banks may recognize interest on accrual basis only for accounts continuing in ‘standard’ category.
Unrealised Interest Reversal (Para 3.2): All unrealised accrued interest must be reversed when an account turns NPA. However, for loans with sanctioned moratorium, capitalized interest accrued during such moratorium need not be reversed.
COVID FITL (March–August 2020): Unpaid FITL due by 31.3.2021 is not reversed, but classified as NPA under the normal 90-day delinquency rule without retrospective penalty. (Refer paragraph 11.185 of Guidance Note 2022).
Changed Accounting Policy on NPA Recoveries
Historically, banks appropriated recoveries in NPA accounts first towards principal to reduce Gross NPAs. Many banks have recently reversed this policy: recoveries (except in One Time Settlements or explicit agreements) are now appropriated towards interest and charges first, and balance towards principal. Auditors must examine quarterly results and accounting policies to ensure compliance. (Refer paragraph 11.131 of Guidance Note 2022).
Schedule 9: Segregation of Intangible Collateral
Advances against intangible securities (rights, licenses, authorities) must be culled out of secured advances and reflected as unsecured advances, with detailed Notes to Accounts disclosures.
For NPAs, the segregated unsecured portion attracts substantially higher provisioning! (Refer paragraph 11.138 of Guidance Note 2022).
CGTMSE & CRGFTLIH Guarantees
When advances covered by CGTMSE or CRGFTLIH become non-performing, no provision is required on the guaranteed portion.
The outstanding amount in excess of the guaranteed portion must be provided for under standard provisioning norms. (Refer Para 5.9.4 of Master Circular and paragraph 11.151 of Guidance Note 2022).
8. Conclusion & Audit Imperatives
Verification of advances and application of IRAC norms continues to be the most critical operational domain in bank audits. While Central Statutory Auditors supervise institution-wide provisioning, branch auditors bear front-line responsibility for rigorous NPA identification and classification.
The regulator’s insistence on daily system-driven reckoning and uncompromising upgradation standards emphasizes zero-tolerance for delinquency masking. Auditors must remain vigilant, study the annual ICAI Guidance Note on Audit of Banks, and never let declining divergence numbers lower their professional skepticism.