CHAPTER II CONCEPTUAL BACKGROUND AND REVIEW OF LITERATURE.

Transcription

1 CHAPTER II CONCEPTUAL BACKGROUND AND REVIEW OF LITERATURE. SR. NO. PARTICULARS PAGE NO. 2.1 CONCEPTUAL BACKGROUND REVIEW OF LITERATURE CONCLUSIONS 56-56

2 2. CONCEPTUAL BACKGROUND AND REVIEW OF LITERATURE 2.1 CONCEPTUAL BACKGROUND: The Indian banking business has made commendable progress in extending its geographical spread and financial reach in the business of accepting deposits & extending credit. One of the major problems being faced the by banks and financial institutions in India today is that of bad debts. The bank provides the credit facility to its customers, which are assets in the form of repayment of interest along with installments of principal. The bank balance sheet shows different kinds of assets such as cash in hand, investment, fixed assets, loans and advances, other assets. The concept of NPA depends on loans & advances, when the loan account generates income regularly it is treated as a performing asset, however when it ceases to generate income, it become non performing asset when it results in losses of income. In other words, a loan asset becomes Non-performing Asset (NPA) when it is not recovered. (Here income means interest, fees and commission etc. to the bank.) Meaning and Definitions According to Tiruttani Munivelu 1 (2000), Non performing assets are index of banking health. High level of NPA is indication of poor credit management. The volume of NPA affects the yield on advances. Reddy B R 2 says (2001), NPAs indicates grater incidence of credit risk and larger failure in assessing credit risk. In fact it is the level of NPA which to a great extent differentiate between good and bad bank. Joseph F Sinkey 3 says Transformation of bank s liabilities and equity into assets can be viewed as a production process. The quality of these assets determines the viability of the system. The quality of advance has been deteriorating for which unprecedented rise in non performing advances is responsible. 11

3 Bhaskar Rao 4 (1992) has attempted to define a non-performing asset as, an asset which does not directly contribute to a bank s profitability. Following are some of the non performing assets: a) Excess holding of cash balance b) Mounting overdue and sticky loan c) Bad and doubtful debts d) Deteriorating productivity of employees. He further states that, non-performing assets are essentially loans and advances, interest on which is doubtful to be realized. The banks have always had bad loans or problem loans on the one side and good or performing loans on the other, the concept of non-performing assets in present form gained currency with the default of sovereign loan. E.A.Aveneyou 5 (1988) says Non performing assets are loans for which no interest is paid for a specific period. According to Mrs. Ranjana Kumar 6 (2003) In the process of income recognition some banks landed up in losses and some of them continued to incur losses for quite sometime due to their historical legacy of NPA accounts and they were categorized as Weak Bank The RBI in its circular 7 DBS.CO.PP.BC 9/ / of 21 st December 2002 clarified that to take the action bank reduced net NPA over 10 per cent but less than 15 per cent. P N Joshi 8 (2003) says Non recovered loans were designated as bad and doubtful and the total advance given in the balance sheet was after usual and necessary provisions. In any business bad and doubtful debt is inevitable. Banking is a business and therefore, NPAs can not be altogether avoided. Non-performing assets means an asset or account of a borrower, which has been classified by a bank or financial institution as sub- standard, doubtful or loss asset, in accordance with the direction or guidelines relating to asset classifications issued by the Reserve Bank 12

4 The Securities and Exchange Commission of the United States defined non performing loans as Loans which are contractually past due for 90days or more as to interest or principal payments and loans, the term of which has been renegotiated to provide a reduction or deferral of interest or principal Any of the bank s balance sheets consists two main categories one is financial assets and the second, infrastructure assets ranging from items of stationery to premises. The financial assets include cash balance, investment, loans and advances etc. In loans and advances two types of advances, one performing advances mean a consistent and regular mode of repayment of interest along with installment of principal amount and Non performing advances means not making repayment of interest along with the installment of principal amount. In other words P A means paisa aaya and NPA means paisa nahi aaya. T. P. Mishra 9 (2003) has opined that, the concept of Non performing Asset is subjective to varying perception and discretion of Branch Manager in classifying bad and doubtful assets and it has since been rescinded and status of the advance and principal of income recognition has been stabilized within the purview the new definition of NPA and prudential norms. P. N. Joshi 10 (2004) says NPA means due interest on loan or the installment of the principal is not paid within 90 days, the account is treated as NPA. Non performing Asset means income, was essential in order to ensure that the bank takes into account the income which was actually realized but the income which does not take into account needs to provision requirement on other head. According to The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Ordinance 11 (2002), Non Performing Asset means an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss assets, in accordance with the directions or guidelines relating to assets classifications issued by the RBI. A Non performing Asset (NPA) was defined as a credit facility in respect of which the interest along with the and or installment of principal has 13

5 remained past due for a specified period of time. The specified period was reduced to four quarters during the year ending 31 st March 1993.Three quarters during the year ending 31 st March 1994, two quarters during the year ending 31 st March One quarter during the year 31 st March Due to the improvement in the payment and settlement systems recovery climate, up-gradation of technology in the banking system, etc it was decided by RBI to dispense with past due or NPA since date concept, with effect from 31 st March Non performing asset shall be defined as an advance or credit facility under RBI guidelines 12 : a) Interest and or installment of principal remain over due for a period of more than 180 days (90 days 31 st March 2004) in respect of a Term Loan. b) The account remains out of order for a period of more than 180, days (90 days 31 st March 2004) in respect of an overdraft / cash credit (CC/OD) c) The bill remains over due for a period of more than 180 days (90 days 31 st March 2004) in the case of bills purchased and discounted, d) Interest and / or installment of principal remains over due for two harvest seasons but for a period not extending two half year in the case of an advance granted for agricultural purposes and e) Any amount to be received remains overdue for a period of more than 180days (90 days 31 st March 2004) in respect of other accounts. Adoption of 90 days Norms for Recognition of Loan Impairment from 31 st March 2004 was with a view to moving towards international best practices and to ensure greater transparency. The RBI has advised that the banks are, therefore, required to chalk out an appropriate transition path for smoothly moving over to the 90days norm. As a facilitating measure, bank should move over to charging of interest at monthly rests by 1 st April Banks would have to substantially upgrade their existing Management Information System ( MIS) for collecting data on loans, where interest and / or installment of principal remains overdue for a period of more 14

6 than 90days in order to crystallize NPAs on a 90 days norm. consequent effect on implementation of new concept of NPAs will be - However The weakness of whole financial system and the governance of Financial Institutions will be exposed significantly. The gravity of the situation may be exhibited from the fact that the gross NPAs of banking system amounted to Rs Crores in , which were blocked. This position deteriorates the implementation of proposed assets classification norms. Further lightening the provisioning norms will definitely eat into size of bank profitability because the lender is not allowed to book any income from the assets it is classified as nonperforming assets. As also, the changes, from time to time in the definition of NPAs, abruptly turned many good loans in to bad loans Defaulter One who has failed or neglected to do his duty. One from whom any money or other things is due and has failed to pay Over due Any amount due to the bank under any credit facility is overdue if it is not paid on the due date fixed by the bank Due Date Due date is the monthly/quarterly/ half-yearly date fixed or stipulated in the loan sanction letter for repayment of loan installments and/ or interests regularly Out of Order An account should be treated as out of order if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. In 15

7 case where the outstanding balance in the principal operating account is less than sanctioned limit/ drawing power, but there are no credit continuously for three months or ninety days as on the date of balance sheet or Credits are not enough to cover the interest debited during the same period Past Due: As assets was classified as NPAs if the amounts due in the account remained were past due for two quarters. It was clarified on 17 December 1992, that amount considered past due when it remains outstanding 30 days beyond on due date. Due to the improvements in the payment and settlement system, recover climate, upgardaion technology in the banking system etc. It was decided to dispense with past due concept, with effect from 31March The prudential accounting norms based on the NPA concept. Non performing Asset (NPA) leads to N P & A, here N stands for No Income P for Provisioning and A for Asset Classification. The prudential accounting norms comprise of the following three norms - 1) Income Recognition 2) Assets classification 3) Provisioning Income recognition Interest income should not be recognized until it is realized. A Non Performing Asset is one when interest is overdue for one or for more quarters. In respect of nonperforming asset interest is not to be recognized on accrual basis but is to be treated as income only when it is actually received. Income recognition policy as per RBI Circular 13 DBOD No. BP.BC /20/ / Dated 1 st September 2001.The policy of income recognition has to be objective and based on the record of recovery. Internationally income from nonperforming assets (NPA) is not recognized on accrual basis but is booked as income only when it is actually received. Therefore, the banks should not charge and take to income account interest on any NPA. However, interest on advance against term deposits NSCs, IVPs, KVPs and LIC policies may be taken to 16

8 income account on the due date, provided adequate margin is available in the accounts. Fees and commissions earned by the banks as a result of renegotiation or rescheduling of outstanding debts should be recognized. If Government guaranteed advance become NPA, the interest on such advance should not be taken to income account unless the interest has been realized Asset classification Banks are required to classify performing and non performing assets and again non-performing assets(npa) are classified into sub-standard, doubtful and loss assets. Diagram No 1 : Loan Assets for Assets Classification LOAN ASSETS Performing Assets (P A) Non- Performing Assets (NPA) Standard Assets Sub-standard Assets Doubtful Assets Loss Assets 17

9 2.1.8 (a) Standard Assets A standard asset is a credit facility, which is not treated as NPA and which does not carry normal credit risk attached to a business. For the year ending 31 st March 2000, the bank should make a general provision of minimum of 0.25 percent on standard account. RBI Circular 14 DBOD.No.BP.BC./20/ / Dated 1 st September (b) Sub-standard Assets A sub- standard asset was a credit facility, which was classified as NPA for a period not exceeding two years. However, with effect from 31 st March 2001, a sub standard asset is one, which has remained NPA for a period less than or equal to 18 months. With effect from 31 st March 2005 which has remained NPA for a period less than or equal to 12 months. The sub standard assets can be classified into two categories depending upon their NPA period. Sub standard asset I is less than or equal to 12 months and Sub standard II is more than 12 months, but less than 18 months (c) Doubtful Assets : A doubtful asset is a credit facility, which remained NPA for a period of exceeding 18 months for the purpose of provisioning a doubtful asset is again classified into the following sub- categories Category Status as Doubtful Status as NPA Asset a)a ) Doubtful 1 ( DF-1) Up to 1year Up to 2 ½ years only b) Doubtful 1 ( DF-2) More than 1 to 3 year More than 2 ½ to 4 ½ year c) Doubtful 1 ( DF-3) More than 3 year More than 4 ½ year 18

10 2.1.8 (d) Loss Assets : A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection, but the amount has not been written off Interest Suspense Account: The balance in this account represents interest on NPA debited to respective borrowers account in accordance with the terms of the agreement but not recognized as in (Interest Suspense Account can also be sometimes termed as overdue interest on Non Performing Assets) Overdue Interest on performing Assets : The balance in this account represent accrued interest on performing advance debited to respective borrower account and though not actually recovered is recognized as income in the books of the bank Bad and Doubtful Debts Reserve (BDDR): The balance in this account represents amount of provision to be made on principal balance of Non Performing Advance Provisioning for Loan and Advances As per the categories of loan assets the bank are expected accordingly to make sufficient provision against each of the NPA account for possible loan losses as per prudential norms. The provision made by the RBI Inspectors and the bank management and the statutory auditor in taking a decision, in accordance to prudential guidelines. a) Standard Asset A general provision of 0.25% on standard assets on global loan portfolio. b) Sub- Standard Asset A general provision of 10% of the total outstanding. 19

11 c) 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. Regarding to the secured portion provision may be made on the following basis, the provision should be made at the rates ranging from 20 percent to 50 percent of the secured portion, that depends upon the period for which the assets have remained doubtful. Period for which the advance has been Provision requirement (%) considered as doubtful Up to one year 20 One to three year 30 More than three year 50 d) Loss Assets : The entire asset should be written off,if the assets are permitted to remain in the books for any reason. Provision required is 100% of the outstanding balance of the loss assets. Provisioning Norms (Tabular Form) Asset Category Standard Assets Sub standard Assets Doubtful Asset Loss Asset Provision Requirement Minimum 0.25% on standard assets on global loan portfolio basis 10% of the total outstanding balance 1) 100% to unsecured portion plus 2) Depending upon the age of doubtful period of the secured portion Up to 1Year 20% One to 3 Year 30% More than 3 Year 50% 100% of the outstanding balance 20

12 Asset Cycle The bank gets loan to his borrower, and bank converts loan into asset. Firstly loan asset is a performing assets. This performing asset is known as standard asset, which does not carry more than normal risk attached to the business. When borrower makes delay for repayment of his amount remaining one quarter or more of its 90 days, depending upon the nature of the account, it becomes a potential NPA. The borrower overdue amount is not recovered exceeding 18 months, such account is known as sub standard asset, and then it becomes doubtful asset and loss asset. The standard asset potential NPA and sub standard asset may slip into doubtful asset/loss asset. It carries more normal risk business. Loss can be converted to doubtful asset/sub standard. The standard assets convert to cash in an asset cycle by recovery of due amount as per the sanction. But sub standard asset as well as doubtful asset can convert into cash recovery/legal process/compromise. Loss assets convert into cash or liquidated by write- off/compromise/legal process/cash recovery, than bank loss convert to profit. Diagram No 2 : Asset cycle Standard Assets NPA Recovery Action Potential NPA Recovery Loss Asset Sub Standard Asset Doubtful Asset 21

13 The three aspects of prudential norms, one is income recognition second is assets classification and third is provisioning, are important, it is based on concept of performance instead of the health of the loan assets RBI Guidelines for NPA Norms On the basis of the same, the RBI issued detailed guidelines and instructions to banks in 1992 on a number of issues. The RBI working group under chairmanship of Shri S.S.Tarapore, Deputy Governor of the RBI examine the various aspects of the prudential norms. The RBI for the first time issued guidelines /clarifications (Cir NO DBOD April 27, 1992 and December 17, 1992). The NPA norms were applied since 1992 for nationalized and for Urban co- operative banks since 1993 and after 1997, RBI included District Central Co- Operative Banks. To understand guidelines of Non-Performing Asset issued by RBI time to time implemented and revised is my main object of research. (A) The first guidelines issued by RBI included the following: Prudential norms in respect of Income Recognition, Assets classification, Provisioning: In terms of the Memorandum of Instructions endorsed to our Cir. UBD. No I&L 38/J.I.92/93date 9February 1993,primary Co-operative banks were advised, among others, that they should not charge and take to Income account interest accrued on non- performing assets ( NPA). It was also clarified vide paragraph 1 of our Cir UBD. No. I&L 38/J.I.92/93date 17June 1993 that interest accrued on non-performing assets could be shown separately or parked in a separate account. It has been observed in the course of primary inspection of co operative banks that different practices are being followed by them while accounting for accrued interest of non performing assets The provisions in the State Co-operative Societies Act of different states prescribed in this regard also vary. While in certain states, bank have to take accrued interest as Income and make corresponding provision to the extent of interest not actually received. In certain other State, interest actually received is only to be treated as income and taken to the profit and loss account. 22

14 Interest accrued in respect of non-performing advances should not be debited to borrower account 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. In respect of borrower accounts which are treated as performing assets, accrued interest can alternatively be debited to the borrower account and credited to Interest account and taken to income account. In such case where the accrued interest has been debited to such borrower account but not received before the end of the accounting year viz, 31 st March, equivalent amount corresponding to such unrealized interest should be reversed by debit to profit and loss account and credited to Overdue Interest Reserve Account. Making provisions in respect of the Non Performing Assets as at the end of 31 st March of every year, the amount of accrued interest debited to borrower accounts of performing assets but not actually realized before the end of 31 st March of the same year and therefore transferred to Overdue Interest Reserve account by debit to profit and loss account, may be deducted from the Aggregate loan and advance. In this connection,a reference is also invited to Para 6 of the Memorandum of Instructions enclosed with Cir I&L.38/J-1-92/93 dated 9 th February 1993, Which states that interest accrued and credited to income account in respect of non-performing assets for the earlier year but not actually realized should be provided for in the current accounting year. It may be clarified that overdue interest reserve is not created out of the real or earned Income received by the bank and as such, the amounts held in the Overdue Interest Reserve Account amount be treated as reserve or a part of the owned funds of the bank. It will also be observed that the balance sheet format prescribed under the Third Schedule to the Banking Regulation Act 1949 (As Applicable to Co-operative Societies) specifically requires the bank to show Overdue Interest Reserve as distinct item on the Capital and Liabilities side. Each bank is required to have a Loan Recovery Policy which sets down the manner of recovery do dues, targeted level of reduction norms for permitted sacrifice, factors to be taken into account before considering sacrifice, decision 23

15 levels, reporting to higher authorities and monitoring of write off/ sacrifice cases. The compromise should be a negotiated settlement under which the banks should ensure to recover its dues to the maximum extent possible at lower expense. It is necessary that a proper distinction should be made between willful defaulters and the borrowers defaulting in repayments. Security is available for assessing the realizable value; proper weightage has to be given to the location, condition and marketable title and possession thereof. The proposals for write-off / compromise falling within the authority of Management Committee, Board of Directors, Chief General Manager and General Manager. The Reserve Bank of India has suggested to the banks to formulate a suitable scheme for settlement of chronic over due loan. (B) The second guidelines issued by RBI included the following: - Prudential norms in respect of Recovery of Dues relating to NPA& One Time settlement (OTS) The RBI guidelines aimed at ensuring transparency and credibility of financial position of banks. The RBI has advised all commercial banks that the broad framework for compromise and settlements of NPA outlined July on 1995 will continue to be in place. The recovery position in respect of borrowers other than small sector had not been satisfactory. In July 2000, RBI further modified the guidelines, which were simple, non-discretionary and non-discriminatory guidelines for recovery stock of NPAs relating to all sectors including small sector banks, to be unimplemented in all banks. The guidelines covered accounts up to Rs. 5 Crore. In these however do not cover Cases of willful default, fraud and malfeasance. The banks should identify cases of willful default, fraud and malfeasance and prompt take action against them. Given that the purpose of the guidelines on settlement of NPAs was to provide an opportunity for one-time settlement within a specifie time period. The minimum amount that should be recovered under OTS guidelines in respect of compromise of NPAs classified as doubtful or loss as on March 1997 would be 100% of outstanding balance. CEO & General Manager should personally supervise the NPAs of Rs 5 crore and above case to case basis. 24

16 The policy guidelines on settlement of NPAs position, statements and report time to time sent copy to RBI. The RBI has extended the deadline for accepting request for One Time Settlement (OTS) of chronic NPAs of public sector bank for an amount upto Rs 10 crore from 30 th April 2003 to 30 th September In terms of our Cir. DBOD. No.BP.BC. 129/ dated 24 th April1992, read with DBOD. No. BP.BC 31/ /99dated 24 th April1999,bank were advised,inter alia that a standard assets where the terms of loan agreement regarding interest and principal have been renegotiated or rescheduled after commencement of production should be classified as sub-standard and should remain in such category for least one year of satisfactory performance under the renegotiated or rescheduled terms. In the case of sub-standard and doubtful assets also, rescheduling does not entitle a bank to upgrade the quality of advance automatically unless there is satisfactory performance under the rescheduled /renegotiated terms Further in terms of Cir. DBOD. No. BP.BC. 45/ /99 dated 10 th May 1999, in case where commercial production had commenced but not stabilized, it was left to the Board of Directors of the banks to decide whether there is a need for rescheduling of the loan and treat the account as standard assets subject to certain conditions stipulated therein. It has, however, been represented to us that the foregoing stipulations deter the banks from restructuring of standard and sub standard loan assets even though the modification to terms might not jeopardized the assurance of repayment of dues from the borrower. The present norms have, therefore, been reviewed in the light of the international best practices and the BIS guidelines in the matter and it has been decided to effect certain changes in the norms relating to restructuring / rescheduling / renegotiation of terms of the standard and sub- standard loan assets, as detailed in the following. The prudential treatment of the accounts, subjected to restructuring rescheduling / renegotiation of terms, would be governed by the following norms: 25

17 Treatment of restructured standard and Sub standard accounts A rescheduling of the installments of principal alone, at any of the aforesaid first two stages would not cause a standard asset to be classified in the sub standard category provided the loan /credit facility is fully secured. A rescheduling of the interest element at any of the foregoing first two stages would not cause an assets to be sub standard category subject to the condition that the amounts of sacrifice, if any,in the element of interest, measured in present value terms, is either written off- or provision is made to the extent of the sacrifice involved. For the purpose, the future interest due as per the original loan agreement in respect of an account should be discounted to the present value at a rate appropriate to the risk category to the borrower (i.e. current PLR + the appropriate credit risk premium for the borrower category) and compared with the present value of the dues expected to be received under the restructuring package, discounted on the same basis. In case there is a sacrifice involved in the amount of interest in present value terms, as at above, the amount of sacrifice should either be written off or provision made to the extent of the sacrifice involved. Even in case where the sacrifice is by way of write off the past interest due, the asset should continue to be treated as sub-standard. Above standard, sub- standard accounts which subjected to restructuring etc, whether in respect of principal installment or interest amount, by whatever modality, would be eligible to be upgraded to the standard category only after the specified period, i.e. a period of one year after the date when first payment of interest or of principal, which is earlier, fall due, subject to satisfactory performance during the period. The amount of provision made earlier, net of the amount provided for the sacrifice in the interest amount in present value terms as aforesaid, could also be reversed after the one year period. During this period of a year, the sub-standard asset does not deteriorate. In case, however, the satisfactory performance during the one year period is not evidenced, the asset classification of the restructured account would be governed as per the applicable prudential norms with reference to the pre restructuring payment schedule. 26

18 (C) The third guidelines issued by RBI included the following : Divergence arising out of flexibility in the instructions issued by RBI on income recognition, asset classification and provisioning Based on the discussions, the Group identified RBI instruction on prudential norms which lent scope for difference in interpretation between banks, Statutory Auditors and Inspecting Officers of RBI. In the light of the recommendations of the Group, it has been decided to clarify some of the extant guidelines on prudential norms relating to income recognition, asset classification and provisioning issued vide our Cir. DBOD. No.BP.BC.9/ /97 Dated 9 January a) Temporary irregularities Bank 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 three months, would be deemed as irregular. A working capital borrower account will become NPA if such irregular drawings are permitted in the account for a continuous period of 180days (90days with effect from ), even though the unit may be working or the borrower s financial position is satisfactory. Regular and adhoc credit limits need to be reviewed / regularized 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 180days (90days with effect from ), from the due date /date of adhoc sanction will be treated as NPA. 27

19 b) Regularization of the account around the date of balance sheet : The borrower s account as standard if it has been irregular for major part of the year, but has been regularized near the balance sheet date. The asset classification of borrower s where a solitary or few credit 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 demanded as a NPA. In other genuine cases, the banks must furnish satisfactory evidence to the Statutory Auditors / Inspecting Officers about the manner of regularization of the account to eliminate doubts on their performing status. c) Classification of NPAs where there is a threat to recovery The circular provides that a NPA need not go through the various stages of classification in case of serious credit impairment and such assets should be straightaway classified as a doubtful or 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 percent 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. d) Absence of specific guidelines on certain issues Cir.DBOD.No.BP.BC.9/ /97 dated 29 January 1997,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 remittance 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 bank, the account will be treated as not serviced in the books of the other member bank and therefore, be treated NPA. The bank 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. 28

20 e) Appropriation of Recovery The agreement between the bank and the borrower for the purpose, banks should adopt an accounting principle and exercise the right of appropriation of recoveries in a uniform and consistent manner. Activities allied to agriculture Cir.DBOD.No.BP.BC.17/ /98 dated 4th March 1998 stipulate the income recognition/asset classification norm of two harvest seasons/two halfyear for direct agricultural loan. The term agricultural loan for production and marketing of seasonal agricultural crops such as paddy, wheat, oilseeds, sugarcane etc. In respect of other activities like horticulture, floriculture or allied activities such as animal husbandry, poultry farming etc. assessment of NPA would be done as in the case of other advances. Over dues in other credit facilities A number of banks adopt the practice of parking the dues of the borrower in respect of devolved letters of credit and invoked guarantees in a separate account which is not a regular sanctioned facility. As a result these are not reflected in the principal operating account of the borrower. This renders application of the prudential norms of for identification of NPA difficult it is, therefore, advised that if the debits arising out of devolvement of letters of credit or invoked guarantees are parked in a separate account the balance outstanding in that account also should be treated as a part of borrower s principal operating account for the purpose of application of prudential norms on income recognition, asset classification and provisioning. f) Treatment of loss assets If the realizable value of the security, as assessed by the bank approved values RBI is less than 10 percent of the outstanding in the borrower is accounts, the existence of security should be ignored and the asset should be straightaway classified as loss asset. It may be written off or fully provided for by the bank. 29

21 g) Valuation of security A major source of divergence in provisioning requirement was the realizable value of the primary and collateral security. The value of the security it has been decided that in cases of NPAs with balance of Rs 5 crore and above, The current assets and their valuation are looked into at the time of Statutory Audit. However, in order to enhance the reliability on stock valuation, stock audit at annual intervals by agencies appointed as per the guidelines approved by the Board would be mandatory. Collaterals such as immovable properties charged in favour of the bank should be got valued once in three years by valuers appointed as per the guidelines approved by the Board of Directors. The Reserve Bank of India has issued many circulars for the prudential norms on income recognition, asset classification, and provisioning. In June 2001 RBI issued a Master Circular in order to the banks. In this Master Circular is a compilation of all the instructions contained in these circulars issued by the RBI, DBOD No.BP.BC.20/ / ,Dated September 1, In which circular point out Definitions, Income Recognition, Asset Classification, Provisioning Norms pertaining to the Advances Portfolio. h) Asset Classification Bank are required to classify non performing assets further into the following three categories based on the period for which the asset has remained non performing and the reliability of the dues. 1) Sub standard Assets 2) Doubtful Assets 3) Loss Assets 1) Sub standard Assets A sub- standard asset was one, which was classified as NPA for a period not exceeding two years. With effect from 31March 2001, a substandard asset is one, which has remained NPA for a period less than or equal to 18 months. A loan classified as doubtful, if it has all the weaknesses 30

22 inherent in assets that were 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. 2) Doubtful Assets: A doubtful assets was one, which remained NPA for a period exceeding two years. With effect from 31 March 2001, an asset is to be classified as doubtful, if it has remained NPA for a period exceeding 18 months. A loan classified as doubtful has all the weaknesses inherent in assets that were 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. With effect from 31 March 2005,an asset would be classified as doubtful if it remained in the sub standard category for 12 months. Banks are permitted to phase the consequent additional provisioning over four-year period commencing from the year ended 31 March 2005, with a minimum of 20 per cent each year. 3) Loss Assets: A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. 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. i) Guidelines for Classification of Assets: 1) 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 realization of dues. 31

23 2) Banks should establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of NPA, especially in respect of high value accounts. The bank may fix a minimum cut off point to decide what would constitute a high value account depending upon their respective business levels. The cut off point should be valid for the entire accounting year. 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. j) Internal system for classification of Assets as NPA Bank should establish appropriate internal system to eliminate the tendency to delay or postpone the identification of NPAs, especially in respect of high value of account. The bank may fix a minimum cut-off point to decide what would constitute a high value account depending upon their respective business levels. The cut-off point should be valid for the entire accounting year. Responsibility and validation levels for ensuring proper asset classification may be fixed by the bank. The system should ensure that doubts in asset classification due to any reason are settled through specified internal channels within one month from the due on which the account would have been classified as NPA as per extant guidelines. j- a) Provision norms The primary responsibility for making adequate provision for any diminution in the value of loan assets, investment or order assets is that of the bank managements and statutory auditors. The assessment made by the inspecting officer of the RBI is furnished to the bank to assist the bank management and statutory auditor in taking a decision in regard to making adequate and necessary provisions in terms of prudential guidelines. In conformity with the prudential norms, provision should be made on the non-performing assets on the basis of classification of assets into prescribed categories. Taking into account the time lag between an accounts becoming doubtful of recovery, its recognition as such, the realization of the 32

24 security and the erosion over time in the value of security charged to the bank, the bank should make provision against sub-standard assets, doubtful assets and loss assets as below. j- a-1) Provision on standard assets From the year ending , the bank should make a general provision of minimum of 0.25 percent on standard assets. 1) The provision towards standard assets need not be netted from gross advances but shown separately as Contingent Provision against Standard Assets under Other Funds and Reserves {item.2(viii) of Capital and Liabilities } in the Balance Sheet. 2) In case bank are already maintaining excess provision than what is required /prescribed by Statutory Auditor/ RBI Inspection for impaired credits under Bad and Doubtful Debt Reserve, additional Provision required for Standard Assets may be parked under head Contingent Provisions against Standard Assets with the approval of their Board of Directors. Shortfall if any, on this account may be made good in the normal course. 3) The above contingent provision will be eligible for inclusion in Tier II capital. 4) There is no objection if the banks create bad and doubtful reserve beyond the specified limits on their own or if provided in the respective State Co- Operative Societies Acts. j- a-2) Provision on sub-standard assets A general provision of 10 percent on total outstanding should be made without making any allowance for DICGC/ECGC guarantee cover securities available. j-a-3) Provision on 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 33

25 20 percent to 50 percent of the secured portion depending upon the period for which the assets has remained doubtful. Period for which the advance has been considered as doubtful Up to one year 20 One to three year 30 More than three year 50 Provision requirement (%) As on , 50 percent of the additional provisioning requirement on the assets which become doubtful on account of new norm of 18 month for transition from sub- standard asset to doubtful category. As on , balance of the provision not made during the previous year, in addition to the provisions needed, as on j-a-4) Provision on Loss assets The entire assets should be written off, if the assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for. In respect of advance sanctioned against State Government guarantee w.e.f , if the guarantee get invoked and remains in default for more than 180 days (90 days with effect from ), the banks should make normal provisions. As regards advance guaranteed by State Government in respect of which guarantee stands invoked as on necessary provision should be made, in a phased manner, during the financial year ending to with a minimum of 25 percent each year. Advance against term deposits, NSCs eligible for surrender, IVPs, KVPs, and LICs, are exempted from provisioning requirements. (D) The fourth guidelines issued by RBI included the following: Income Recognition, Asset Classification and Provisioning Asset Classification Adoption of 90 days norm In terms of Cir. No UBD.BSD. I.16/ / dated December 8,2000, a loan classified as a non performing when the interest and 34

26 or installment of principal remains overdue for a period of 90 days, 180 days as against the international best practice of 90days payment delinquency. In the Monetary and Credit Policy Measures for the year ,it has already been announced by the RBI that norm for classification of the asset as nonperforming will be reduce to 90days from 180days as at present. Accordingly, with the effect from March 31, 2004, a non-performing asset (NPA) shall be a loan or an advance. Interest and /or installment of principal remain over due for a period of more than 90days in respect of a term loan, the account remains out of order for a period of more than 90 days, in respect of an Over Draft / Cash Credit. The bill remains overdue for a period of more than 90days, in the case bills of purchased or discounted. Interest and or installment of principal remains over due for harvest seasons but for a period not exceeding two half years in the case of an advance granted for agricultural purposes, and any amount to be received remain overdue for a period of more than 90 days in respect of other accounts. The bank is, therefore, advised to chalk out an appropriate transition path for smoothly moving over 90 days norms. As a facilitating measure, banks should move over to charging of interest at monthly rests, by 1st April 2002.However, the date of classification of an advance as NPA should not be changed on account of charging of interest at monthly rests. Bank should have substantially upgrade their existing MIS for collecting data on loans, where the interest or installments of principal remain overdue for a period of more than 90 days NPA norms. In terms of extant prudential regulations, bank are required to make provision as under in respect of various categories of assets. We have been constantly reviewing the regulatory requirement in respect of prudential provisions and it is proposed to gradually enhance provisioning requirement in future. Considering that higher loan loss provisioning adds to the overall financial strength of banks and the stability of the financial sector. The NPA provision has been made on the principal outstanding depending upon category. 35

27 Asset Classification Provision Requirements Standard Assets 0.25 percent Sub Standard Assets 10 percent Doubtful Assets Between 20 percent to 50 Per cent of the secured Portion depending on the age of NPA and 100 per cent of the unsecured portion. Loss Assets 100 per cent We have been constantly reviewing the regulatory requirements in respect of prudential provision and it is proposed to gradually enhance provisioning requirement in future. Considering that higher loan loss provisioning adds to the overall financial strength of the bank and the stability of the financial sector. Bank are urged to voluntarily set apart provisions much above the minimum prudential levels as desirable practice. Norms on Income Recognition, Asset Classification and Provisioning Agricultural Advance Cir. No.BP. BC. 132/ / date 14 June 2001 on the above subject advising bank that the norm of two harvest seasons not exceeding two half years for reckoning NPAs should be made applicable only in respect of short term agricultural loan for production and marketing of seasonal agricultural crops such as paddy, wheat, oil seeds, sugarcane, etc. In respect of financing of other activities like horticulture, floriculture or allied activities such as animal husbandry, poultry farming, identification of NPA would be done as in the case of other advances. In view of the representations received from banks and the difficulties expressed by them, the issue has been reviewed and it has been decided that the relaxed delinquency norm of two harvest season, not exceeding two half years, which is applicable to all direct agricultural advance list. Master Cir. No RPCD.PLAN.BC. 12/ / dated 1Augsut 2001.In respect of 36

28 agricultural loans, other than those specified above; identification of NPAs would be done on the same basis as non agricultural which, at present, is the 180 days delinquency norm. As per the recent RBI circular for agricultural Advances included shortterm, medium, long term loans. Short term means advance upto Rs 1 Lakh to farmer against pledge /hypothecation of agricultural produce for a period not exceeding 6 months. Medium & long term loan will include for agricultural equipment & machinery, development of irrigation potentials, purchased & Installation of pump, reclamation of land, construction of farm buildings and storage facilities. In respect of other activities like horticulture, floriculture, or allied activities such as animal husbandry, poultry farming, etc assessment of NPA would be done as in the case of other advances. Cir. NO CNO./ Audit 1157/ date 10 June2003 & RBI. No BPD/CIR48/ / Date 22 May 2003 as announced in Governor s Statement on Monetary and Credit Policy for year , it has been decided to exempt both gold loan and small loans upto Rs 1.00 lakh from the 90 days norm for recognition of loan impairment. These loans would therefore continue to be governed by the 180 days norm for classification as NPA even after 31 March Suggestion of various guidelines of RBI Suggestion of various guidelines from time to time issued to the bank regarding prudential norms of NPA. First prudential norms of NPA circular issued by RBI, that time specified period was four quarter remain over due till, todays 90 days norms. NPA norms implication on banking industries to devoting effect on the bank balance sheet as well as economic condition of the country. Govt. of India has taken a number of steps to improve the legal framework covering recovery of due banks and financial institutions. Valuation of investment method to be adopted by bank. The RBI to advice any appreciation in value of securities on the method. In these guidelines excess provision for depreciation in investment for specified financial year also provision should be made to transferred profit & loss A/c under the head 37