NON PERFORMING ASSETS (NPA) 1.

0 WHAT IS A NPA (NON PERFORMING ASSET) Action for enforcement of security interest can be initiated only if the secured asset is classified as Nonperforming asset. Non performing asset means an asset or account of borrower ,which has been classified by bank or financial institution as sub standard , doubtful or loss asset, in accordance with the direction or guidelines relating to assets classification issued by RBI . An amount due under any credit facility is treated as past due when it is not been paid within 30 days from the due date. Due to the improvement in the payment and settlement system, recovery climate, up gradation of technology in the banking system etc, it was decided to dispense with past due concept, with effect from March 31, 2001. Accordingly as from that date, a Non performing asset shell be an advance where
i.

Interest and/or instalment of principal remain overdue for a period of more than 180 days in respect of a term loan, The account remains out of order for a period of more than 180 days ,in respect of an overdraft/cash credit (OD/CC) The bill remains overdue for a period of more than 180 days in case of bill purchased or discounted. Interest and/or principal remains overdue for two harvest season but for a period not exceeding two half years in case of an advance granted for agricultural purpose ,and Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts

ii.

iii. iv.

v.

With a view to moving towards international best practices and to ensure greater transparency, it has been decided to

adopt 90 days overdue norms for identification of NPAs ,from the year ending March 31,2004,a non performing asset shell be a loan or an advance where; i. Interest and/or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan, The account remains out of order for a period of more than 90 days ,in respect of an overdraft/cash credit (OD/CC) The bill remains overdue for a period of more than 90 days in case of bill purchased or discounted. Interest and/or principal remains overdue for two harvest season but for a period not exceeding two half years in case of an advance granted for agricultural purpose ,and Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts

ii.

iii. iv.

v.

Out of order An account should be treated as out of order if the outstanding balance remains continuously in excess of sanctioned limit /drawing power. in case where the out standing balance in the principal operating account is less than the sanctioned amount /drawing power, but there are no credits continuously for six months as on the date of balance sheet or credit are not enough to cover the interest debited during the same period ,these account should be treated as out of order.

Overdue

Any amount due to the bank under any credit facility is overdue if it is not paid on due date fixed by the bank.

FACTORS FOR RISE IN NPAs

The banking sector has been facing the serious problems of the rising NPAs. But the problem of NPAs is more in public sector banks when compared to private sector banks and foreign banks. The NPAs in PSB are growing due to external as well as internal factors.

EXTERNAL FACTORS Ineffective recovery tribunal The Govt. has set of numbers of recovery tribunals, which works for recovery of loans and advances. Due to their negligence and ineffectiveness in their work the bank suffers the consequence of non-recover, their by reducing their profitability and liquidity.

Wilful Defaults There are borrowers who are able to payback loans but are intentionally withdrawing it. These groups of people should be identified and proper measures should be taken in order to get back the money extended to them as advances and loans.

 Natural calamities This is the measure factor, which is creating alarming rise in NPAs of the PSBs. every now and then India is hit by major natural calamities thus making the borrowers unable to pay back there loans. Thus the bank has to make large amount of provisions in order to compensate those loans, hence end up the fiscal with a reduced profit.

Mainly ours framers depends on rain fall for cropping. Due to irregularities of rain fall the framers are not to achieve the production level thus they are not repaying the loans.

Industrial sickness Improper project handling , ineffective management , lack of adequate resources , lack of advance technology , day to day changing govt. Policies give birth to industrial sickness. Hence the banks that finance those industries ultimately end up with a low recovery of their loans reducing their profit and liquidity.

Lack of demand Entrepreneurs in India could not foresee their product demand and starts production which ultimately piles up their product thus making them unable to pay back the money they borrow to operate these activities. The banks recover the amount by selling of their assets, which covers a minimum label. Thus the banks record the nonrecovered part as NPAs and has to make provision for it.

Change on Govt. policies

With every new govt. banking sector gets new policies for its operation. Thus it has to cope with the changing principles and policies for the regulation of the rising of NPAs.

The fallout of handloom sector is continuing as most of the weavers Co-operative societies have become defunct largely due to withdrawal of state patronage. The rehabilitation plan worked out by the Central govt to revive the handloom sector has not yet been implemented. So the over dues due to the handloom sectors are becoming NPAs.

INTERNAL FACTORS

Defective Lending process There are three cardinal principles of bank lending that have been followed by the commercial banks since long. i. ii. iii. Principles of safety Principle of liquidity Principles of profitability

i. Principles of safety

By safety it means that the borrower is in a position to repay the loan both principal and interest. The repayment of loan depends upon the borrowers:

a. Capacity to pay

b. Willingness to pay

Capacity to pay depends upon: 1. Tangible assets 2. Success in business Willingness to pay depends on: 1. Character of borrower 2. Honest 3. Reputation

The banker should, there fore take utmost care in ensuring that the enterprise or business for which a loan is sought is a sound one and the borrower is capable of carrying it out successfully .he should be a person of integrity and good character.

Inappropriate technology Due to inappropriate technology and management information system, market driven decisions on real time basis can not be taken. Proper MIS and financial accounting system is not implemented in the banks, which leads to poor credit collection, thus NPA. All the branches of the bank should be computerised.

Improper swot analysis

The improper strength, weakness, opportunity and threat analysis is another reason for rise in NPAs. While providing unsecured advances the banks depend more on the honesty, integrity, and financial soundness and credit worthiness of the borrower. Banks should consider the borrowers own capital investment. it should collect credit information of the borrowers from a. From bankers b. Enquiry from market/segment of trade, industry, business. c. From external credit rating agencies. Analyse the balance sheet True picture of business will be revealed on analysis of profit/loss a/c and balance sheet. Purpose of the loan When bankers give loan, he should analyse the purpose of the loan. To ensure safety and liquidity, banks should grant loan for productive purpose only. Bank should analyse the profitability, viability, long term acceptability of the project while financing. Poor credit appraisal system Poor credit appraisal is another factor for the rise in NPAs. Due to poor credit appraisal the bank gives advances to those who are not able to repay it back. They should use good credit appraisal to decrease the NPAs.

Managerial deficiencies

The banker should always select the borrower very carefully and should take tangible assets as security to safe guard its interests. When accepting securities banks should consider the 1. Marketability 2. Acceptability 3. Safety 4. Transferability.

The banker should follow the principle of diversification of risk based on the famous maxim do not keep all the eggs in one basket; it means that the banker should not grant advances to a few big farms only or to concentrate them in few industries or in a few cities. If a new big customer meets misfortune or certain traders or industries affected adversely, the overall position of the bank will not be affected. Like OSCB suffered loss due to the OTM Cuttack, and Orissa hand loom industries. The biggest defaulters of OSCB are the OTM (117.77lakhs), and the handloom sector Orissa hand loom WCS ltd (2439.60lakhs). Absence of regular industrial visit The irregularities in spot visit also increases the NPAs. Absence of regularly visit of bank officials to the customer point decreases the collection of interest and principals on the loan. The NPAs due to wilful defaulters can be collected by regular visits.

Re loaning process

Non remittance of recoveries to higher financing agencies and re loaning of the same have already affected the smooth operation of the credit cycle. Due to re loaning to the defaulters and CCBs and PACs, the NPAs of OSCB is increasing day by day. PROBLEMS DUE TO NPA 1. Owners do not receive a market return on there capital .in the worst case, if the banks fails, owners loose their assets. In modern times this may affect a broad pool of shareholders. 2. Depositors do not receive a market return on saving. In the worst case if the bank fails, depositors loose their assets or uninsured balance. 3. Banks redistribute losses to other borrowers by charging higher interest rates, lower deposit rates and higher lending rates repress saving and financial market, which hamper economic growth. 4. Non performing loans epitomise bad investment. They misallocate credit from good projects, which do not receive funding, to failed projects. Bad investment ends up in misallocation of capital, and by extension, labour and natural resources.
5.

Non performing asset may spill over the banking system and contract the money stock, which may lead to economic contraction. This spill over effect can channelize through liquidity or bank insolvency: a) when many borrowers fail to pay interest, banks may experience liquidity shortage. This can jam payment across the country, b) illiquidity constraints bank in paying depositors .c) undercapitalised banks exceeds the banks capital base.

Since high level of NPAs dampens the performance of the banks identification of potential problem accounts and their close monitoring assumes importance. Though most banks have Early Warning

Systems (EWS) for identification of potential NPAs, the actual processes followed, however, differ from bank to bank. The EWS enable a bank to identify the borrower accounts which show signs of credit deterioration and initiate remedial action. Many banks have evolved and adopted an elaborate EWS, which allows them to identify potential distress signals and plan their options beforehand, accordingly. The early warning signals, indicative of potential problems in the accounts, viz. persistent irregularity in accounts, delays in servicing of interest, frequent devolvement of L/Cs, units financial problems, market related problems, etc. are captured by the system. In addition, some of these banks are reviewing their exposure to borrower accounts every quarter based on published data which also serves as an important additional warning system. These early warning signals used by banks are generally independent of risk rating systems and asset classification norms prescribed by RBI. The major components/processes of a EWS followed by banks in India as brought out by a study conducted by Reserve Bank of India at the instance of the Board of Financial Supervision are as follows: Designating Relationship Manager/ Credit Officer for monitoring account/s Preparation of `know your client profile Credit rating system Identification of watch-list/special mention category accounts

Monitoring of early warning signals Relationship Manager/Credit Officer The Relationship Manager/Credit Officer is an official who is expected to have complete knowledge of borrower, his business, his future plans, etc. The Relationship Manager has to keep in constant touch with the borrower and report all developments impacting the borrowable account. As a part of this contact he is also expected to conduct scrutiny and activity inspections. In the credit monitoring process, the responsibility of monitoring a corporate account is vested with Relationship Manager/Credit Officer. Know your client profile (KYC) Most banks in India have a system of preparing `know your client (KYC) profile/credit report. As a part of `KYC system, visits are made on clients and their places of business/units. The frequency of such visits depends on the nature and needs of relationship. Read More: Know Your Customer (KYC) Credit Rating System The credit rating system is essentially one point indicator of an individual credit exposure and is used to identify measure and monitor the credit risk of individual proposal. At the whole bank level, credit rating system enables tracking the health of banks entire credit portfolio. Most banks in India have put in place the system of internal credit rating. While most of the banks have developed their own models, a few banks have adopted credit rating models designed by rating agencies. Credit rating models take into account various types of risks viz. financial, industry and management, etc. associated with a borrowable unit. The exercise is generally done at the time of sanction of new borrowable account and at the time of review / renewal of existing credit facilities. Watch-list/Special Mention Category The grading of the banks risk assets is an important internal control tool. It serves the need of the Management to identify and monitor potential risks of a loan asset. The purpose of identification of potential NPAs is to ensure that appropriate preventive / corrective steps could be initiated by the bank to protect against the loan asset becoming non-performing. Most of the banks have a system to put certain borrowable accounts under watch list or special mention category if performing advances

operating under adverse business or economic conditions are exhibiting certain distress signals. These accounts generally exhibit weaknesses which are correctable but warrant banks closer attention. The categorization of such accounts in watch list or special mention category provides early warning signals enabling Relationship Manager or Credit Officer to anticipate credit deterioration and take necessary preventive steps to avoid their slippage into non performing advances. Early Warning Signals It is important in any early warning system, to be sensitive to signals of credit deterioration. A host of early warning signals are used by different banks for identification of potential NPAs. Most banks in India have laid down a series of operational, financial, transactional indicators that could serve to identify emerging problems in credit exposures at an early stage. Further, it is revealed that the indicators which may trigger early warning system depend not only on default in payment of installment and interest but also other factors such as deterioration in operating and financial performance of the borrower, weakening industry characteristics, regulatory changes, general economic conditions, etc. Early warning signals can be classified into five broad categories viz. (a) Financial (b) Operational (c) Banking (d) Management and (e) External factors. Financial related warning signals generally emanate from the borrowers balance sheet, income expenditure statement, statement of cash flows, statement of receivables etc. Following common warning signals are captured by some of the banks having relatively developed EWS. Financial warning signals Persistent irregularity in the account Default in repayment obligation Devolvement of LC/invocation of guarantees Deterioration in liquidity/working capital position Substantial increase in long term debts in relation to equity Declining sales Operating losses/net losses Rising sales and falling profits Disproportionate increase in overheads relative to sales Rising level of bad debt losses Operational warning signals Low activity level in plant Disorderly diversification/frequent changes in plan Nonpayment of wages/power bills Loss of critical customer/s Frequent labor problems

Evidence of aged inventory/large level of inventory Management related warning signals Lack of co-operation from key personnel Change in management, ownership, or key personnel

Desire to take undue risks Family disputes Poor financial controls Fudging of financial statements

Diversion of funds Banking related signals Declining bank balances/declining operations in the account Opening of account with other bank Return of outward bills/dishonored cheques Sales transactions not routed through the account Frequent requests for loan Frequent delays in submitting stock statements, financial data, etc. Signals relating to

external factors Economic recession Emergence of new competition Emergence of new technology Changes in government / regulatory policies

Natural calamities 2. Management/Resolution of NPAs A reduction in the total gross and net NPAs in the Indian financial system indicates a significant improvement in management of NPAs. This is also on account of various resolution mechanisms introduced in the recent past which include the SRFAESI Act, one time settlement schemes, setting up of the CDR mechanism, strengthening of DRTs. From the data available of Public Sector Banks as on March 31, 2003, there were 1,522 numbers of NPAs as on March 31, 2003 which had gross value greater than Rs. 50 million in all the public sector banks in India. The total gross value of these NPAs amounted to Rs. 215 billion. The total number of resolution approaches (including cases where action is to be initiated) is greater than the number of NPAs, indicating some double counting. As can be seen, suit filed and BIFR are the two most common approaches to resolution of NPAs in public sector banks. Rehabilitation has been considered/ adopted in only about 13% of the cases. Settlement has been considered only in 9% of the cases. It is likely to have been adopted in even fewer cases. Data available on resolution strategies adopted by public sector banks suggest that Compromise settlement schemes with borrowers are found to be more effective than legal measures. Many banks have come out with their own restructuring schemes for settlement of NPA accounts. State Bank of India, HDFC Limited, M/s. Dun and Bradstreet Information Services (India) Pvt. Ltd. and M/s. Trans Union to serve as a mechanism for exchange of information between banks and FIs for curbing the growth of NPAs incorporated credit Information Bureau (India) Limited (CIBIL) in January 2001. Pending the enactment of CIB Regulation Bill, the RBI constituted a working group to examine the role of CIBs. As per the recommendations of the working group, Banks and FIs are now required to submit the list of suit-filed cases of Rs. 10 million and above and suit filed cases of willful defaulters of Rs. 2.5 million and above to RBI as well as CIBIL. CIBIL will share this information with commercial banks and FIs so as to help them minimize adverse selection at appraisal stage. The CIBIL is in the process of getting operationalised.

3. Willful Defaulters RBI has issued revised guidelines in respect of detection of willful default and diversion and siphoning of funds. As per these guidelines a willful default occurs when a borrower defaults in meeting its obligations to the lender when it has capacity to honor the obligations or when funds have been utilized for purposes other than those for which finance was granted. The list of willful defaulters is required to be submitted to SEBI and RBI to prevent their access to capital markets. Sharing of information of this nature helps banks in their due diligence exercise and helps in avoiding financing unscrupulous elements. RBI has advised lenders to initiate legal measures including criminal actions, wherever required, and undertake a proactive approach in change in management, where appropriate. Read : Legal and Regulatory Regimes to Tackle NPAs Source: Scribd.com Related posts:

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Actions taken by RBI and Ministry of Finance to tackle economic problems Non Performing Assets (NPA) Categories of Non Performing Assets (NPAs) Accounting treatments for non performing leases Role of RBI (Reserve Bank of India) in Payment Systems Lending procedures of development banks Important functions of Development Banks Major objectives of Development Banks Definition of Development Banks Official actions to influence foreign exchange rates Management/Resolution of NPAs: Legal and Regulatory Regime The Impact of Rising NPA Levels in Banks Categories of Non Performing Assets (NPAs) Customer Service Strategies in Banking Sector Role of RBI (Reserve Bank of India) in Payment Systems Electronic Cheque Payment System Development of Bank Payment Systems Classification of Bank Payement Systems Introduction to Payment Systems in Banking System Online Banking (E-Banking) Strategies

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Profitability:

NPA means booking of money in terms of bad asset, which occurred due to wrong choice of client. Because of the money getting blocked the prodigality of bank decreases not only by the amount of NPA but NPA lead to opportunity cost also as that much of profit invested in some return earning project/asset. So NPA doesnt affect current profit but also future stream of profit, which may lead to loss of some long-term beneficial opportunity. Another impact of reduction in profitability is low ROI (return on investment), which adversely affect current earning of bank. Liquidity: Money is getting blocked, decreased profit lead to lack of enough cash at hand which lead to borrowing money for shot\rtes period of time which lead to additional cost to the company. Difficulty in operating the functions of bank is another cause of NPA due to lack of money. Routine payments and dues. Involvement of management: Time and efforts of management is another indirect cost which bank has to bear due to NPA. Time and efforts of management in handling and managing NPA would have diverted to some fruitful activities, which would have given good returns. Now days banks have special employees to deal and handle NPAs, which is additional cost to the bank. Credit loss: Bank is facing problem of NPA then it adversely affect the value of bank in terms of market credit. It will lose its goodwill and brand image and credit which have negative impact to the people who are putting their money in the banks.
RESERVE BANK OF INDIA GUIDELINES REGARDING INVESTMENT PORTFOLIO OF THE URBAN COOPERATIVE BANKS (UCBs) : 1. INTRODUCTION As a major element of the Financial Sector Reforms in India, RBI introduced prudential norms for banking regulation. Capital adequacy, exposure ceilings for lending to individual and group of borrowers, marking to market of the investment portfolio and, income recognition, asset classification and provisioning norms for the loan portfolio (IRAC in short) formed the core of prudential regulation. The IRAC norms serve two primary purposes - (i) to depict the true position of a bank's loan portfolio and (ii) to help arrest its deterioration. The Committee on Financial System (CFS), under the Chairmanship of Shri M. Narasimham, recommended a policy of income recognition and asset classification based on record of recovery and other objective criteria as also provisioning based on the classification of assets into different categories. RBI largely accepted the recommendations of the CFS and introduced the IRAC norms for the Urban Cooperative Banks (UCBs) in a phased manner over a three-year period from the year 1992-93.

2. Income recognition (i) Effective from April 1, 1992, banks cannot consider as income interest on loan accounts, classified as NonPerforming Assets (NPA), unless actually received. Such unrealised interest on NPA taken as income in the earlier year has to be provided for. In other words, income from NPA is booked as income only when actually received, and not on accrual basis. (ii) Accrued interest on NPA Banks should not debit to the borrowers accounts interest accrued on NPA, but show them separately under "Interest Receivable Account" and a corresponding amount under "Overdue Interest Reserve Account" on the assets and liabilities side of the balance sheet respectively. (The amount held in the Overdue Interest Reserve Account, however, cannot be regarded as a "reserve" or as part of the owned funds of the Bank as it is not created out of income actually received by the bank). (iii) Accrued interest on performing assets

In respect of loan accounts, classified as performing assets, accrued interest can be debited to the borrowers account and taken to income account. If the relevant credit facility becomes NPA later, the bank should provide for the interest accrued and credited to income account. In such cases, while making provision the amount held in "Overdue Interest Reserve Account" should be deducted from the advances outstanding. (iv) Partial recovery of interest Banks can take partial recovery of interest on NPA to their income account, provided such recovery is not out of fresh / additional credit facilities sanctioned to the borrowers concerned. (v) Income recognition on investments classified as NPA Investments also are subjected to prudential norms on income recognition. As such, banks should not take to income interest on accrual basis in respect of any security irrespective of the category in which it is included, where interest / principal in respect of which is in arrears for more than 90 days. (vi) Others Wherever the State Cooperative Societies Acts prescribe a more stringent accounting procedure, the same should be followed. Further, where the bank has a more stringent accounting procedure, it can continue to follow such a procedure.

3. Non-performing assets A credit facility is considered non-performing when it ceases to generate income for the bank. Earlier, an asset was classified as NPA if interest and / or instalment of principal remained past due for a specific period. Past due was replaced by overdue with effect from the year ended March 31, 2001. Any dues to a bank under a credit facility will be overdue if not paid by the due date fixed by the bank. RBI implemented the 90 days delinquency norm for NPA classification for the UCBs from the year ended March 31, 2004. Given the heterogeneity of the sector, RBI prescribed relaxed IRAC norms for smaller UCBs. Details of those relaxations, together with relaxation in provisioning requirements, are in the Annex. The criteria for treating a loan account as NPA depend on the nature of facility as under: (i) Term loan: A term loan is to be classified as NPA if interest and / or principal remained overdue for more than 90 days. (ii) Cash credit and overdraft account: A cash credit / overdraft account is classified as NPA if the account is out of order for more than 90 days. An account is treated as out of order if the balance outstanding is continuously in excess of the sanctioned limit or drawing power (whichever is lower) or where the outstanding balance in the principal operating account is within the sanctioned limit or drawing power, but there are no credits continuously for 90 days as on the date of balance sheet, or credits made are not enough to cover the interest debited during the same period. (iii) Bills purchased and discounted: A bill is treated as NPA, if it remains overdue and unpaid for a period of more than 90 days. Overdue interest should not be charged or taken to income account in respect of overdue bills, unless it is realised. (iv) Other credit facilities: Any other credit facility is to be treated as NPA, if it remains outstanding for a period of more than 90 days. (v) Agricultural advances: In case of all direct agricultural advances, effective September 30, 2004 an account should be treated as NPA if interest and / or instalment of principal remained overdue for two crop seasons from the due date for short duration crops and one crop season from the due date for long duration crops. Long duration crops have a crop season longer than one year and crops, which are not long duration crops are treated as short duration crops. Depending upon the duration of crops raised by a farmer, the above NPA norms would also be applied to agricultural term loan availed of by

him. The crop season for each crop, which means the period up to harvesting, has to be decided by the State Level Bankers Committee in each state. In respect of other activities like horticulture, floriculture or allied activities such as animal husbandry, poultry farming etc., NPA classification would be done on 90 days impairment norm as in the case of other advances. Few exceptions (a) Housing loans to staff members: Housing loans or similar advances granted to staff members, where interest is payable after recovery of principal should be classified as NPA only when there is a default in payment of interest on due date. (b) Project finance: In the case of project finance, (industrial) where moratorium is allowed for payment of interest / principal, the respective amounts will become due only after moratorium / gestation period is over. (c) Credit facilities guaranteed by Government Credit facilities backed by Central Government guarantee, though overdue, should not be treated as NPA. Therefore, no provision is required to be made on such accounts. Interest on such advances, however, should not be taken to income account unless it has been actually realised. From the year ended March 31, 2006, State Government guaranteed advances and investments in State Government guaranteed securities would attract extant IRAC norms, if interest and / or principal or any other amount due to a bank remains overdue for more than 90 days. A bank is not required to invoke the guarantee before classifying such advances / investments as NPA. (d) Advances against Term Deposits, NSCs etc. Advances against fixed and other term deposits, National Savings Certificates (NSCs), life policies, Indira Vikas Patras (IVPs) and Kisan Vikas Patras (KVPs) need not be treated as NPA although interest thereon is not paid. Interest on such advances may be taken to income account on the due dates, provided adequate margin is available in the accounts. (e) Advances affected by natural calamity Where natural calamities impair the repaying capacity of the agricultural borrower, UCBs may consider i) converting the crop loan in to an agricultural term loan or rescheduling the repayment period and ii) sanctioning fresh short-term loans. In such cases, the term loan or the fresh short-term loan will be treated as current dues and need not be classified as NPA. Asset classification of these loans will be governed by the revised terms and conditions and these would be classified as NPA as per the extant norms applicable for classifying agricultural advances as NPA.

4. Asset Classification In order to facilitate assessment of quality of the advances portfolio and to enable them to make adequate provisions, the UCBs should classify loan assets into the following categories. FEATURE Assets, which do not disclose any problem and do not carry more than the normal risk attached to the business. Such assets are not NPA. Sub-standard Effective from year ended March 31, 2005, assets are classified substandard if they remain non-performing for less than or equal to 12 months. They have well defined credit weaknesses and are characterised by the distinct possibility that the bank will sustain some loss if the deficiencies are not rectified. CATEGORY Standard

1 2

An account, where the terms of loan agreement relating to payment of interest and repayment of principal have been negotiated or rescheduled

Doubtful

Loss

after commencement of production, should be classified as sub-standard and retained as such for at least one year of satisfactory performance under the renegotiated terms. Effective from year ended March 31, 2005, assets are classified doubtful if they remain non-performing for more than 12 months. They have all the weaknesses inherent in sub-standard assets with the added characteristic that collection or liquidation of the dues is highly improbable. As in the case of sub-standard asset, rescheduling does not entitle a bank to upgrade the quality of the account automatically. These are assets where loss has been identified by the bank or internal / external auditors or RBI inspection, but the amount has not been written off, wholly or in part. Such assets are considered uncollectible and of so little value that their continuance as bankable assets is not warranted, even though there may be some salvage or recovery value.

5. Guidelines for asset classification Assets are to be classified generally on the basis of well-defined credit weaknesses and the extent of dependence on collaterals for realisation of dues. Net worth of borrower / guarantor should not be taken into account while determining whether an advance is NPA. Banks should bear in mind the following RBI guidelines for asset classification. (i) Identification of assets as NPA on on-going basis Banks should identify assets as NPA on an on-going basis. They should evolve a system to eliminate the tendency to delay or postpone identification of NPA, particularly in respect of high-value accounts. They should internally resolve doubts regarding asset classification within one month of the date by which the account would have been classified as NPA as per prescribed norms. (ii) Treatment of accounts as NPA a) Record of recovery The classification of an asset as NPA has to be done on the record of recovery. Banks should not classify an account as non-performing due to the existence of temporary deficiencies such as balance exceeding limit, nonavailability of adequate drawing power, non-submission of stock statement or non-renewal of accounts on due date. If an account is regularised before the balance sheet date by repayment of overdue through genuine sources (not by sanction of additional facilities or transfer of funds between accounts), the account need not be treated as NPA. It should, however, be ensured that the account remains in order subsequently and a solitary credit made in the accounts near about the balance sheet date to extinguish the overdue interest or instalment of principal is not reckoned as the sole criterion for treating the account as a standard asset. In other genuine cases, banks must furnish to the Statutory Auditor / RBI Inspecting Officer satisfactory evidence of regularisation of the account. b) Borrower-wise and not facility-wise Where one credit facility extended to a borrower becomes NPA, all the other facilities, even if the operations in those accounts are satisfactory, are required to be treated as NPA. (iii) Potential threats to recovery In respect of accounts where there are potential threats to recovery on account of erosion in the value of security or existence of factors such as frauds committed by borrowers, such accounts should be straightway classified as doubtful or loss asset, as the case may be, irrespective of the period for which they have remained as NPA. Similar treatment should be provided to accounts where there is significant erosion in value of security, i. e. less than 50% of the value assessed by the bank or accepted by RBI at the time of last inspection. (iv) Classification as NPA for arrears in submission of stock statements Outstanding in the account based on drawing power calculated from stock statements older than three months would be considered as irregular. A working capital account will be classified as NPA if such irregular drawings are allowed for more than 90 days.

(v) Classification as NPA for non-review or non-renewal of limits An account where regular / ad-hoc credit limits are not reviewed or not renewed within 90 days from the due date or date of ad-hoc sanction will be classified as NPA. (vi) Treatment of loss assets If the realizable value of the security, as assessed by the bank or approved valuer or RBI, is less than 10% of the outstanding in the borrowers account, existence of security should be ignored and the account should be classified straightway as a loss asset. (vii) Classification of accounts under consortium Asset classification of accounts under consortium will be done on the record of recovery in individual banks. However, where remittances by the borrower under consortium lending arrangements are pooled with one bank, and that bank does not part with the share of a member bank, the account in the member bank will be treated as not having been serviced and will be treated as NPA as per extant norms. (viii) Fixing realistic repayment schedules UCBs should fix monthly / quarterly instalments for repayment of gold loans for non-agricultural purposes after taking in to account the income generation pattern and repayment capacity of the borrower. Such gold loans should be classified as NPA if interest and / or instalment remain overdue for more than 90 days. In case of gold loans for agricultural purpose, interest has to be charged at yearly intervals as per the Supreme Court judgement and payment should coincide with harvesting. Such advances will be NPA only if instalment and / or interest become overdue after the due date. 6. Provisioning (i) In conformity with prudential norms, UCBs should make provisions on the NPAs based on classification of assets in to prescribed categories as detailed in paragraph 4 above. Considering the time lag between an account becoming doubtful of recovery, its recognition as such, the realisation of the security and erosion in the value of security over time, banks are required to make provisions as detailed below against loss, doubtful and sub-standard assets: Asset category 1 Loss 2 Doubtful Provision required The bank should write off the entire outstanding. Otherwise, it has to make 100% provisioning for the outstanding. (a) 100% of the portion not covered by the realisable value of security (b) Over and above item (a) depending upon the period up to which the asset has remained doubtful, 20% 100% of the secured portion (i.e. estimated realisable value) as given below: Period Provision % Up to 1 year 20 1 3 years 30 Over 3 years i) 50 up to Outstanding stock of NPA as on March 31, 2007 31.3. 2007 ii) 60 as on 31. 3. 2008 iii) 75 as on 31. 3. 2009 iv) 100 as on 31. 3. 2010 100

3 Sub-standard

Advances classified as doubtful for more than three years on or after April 1, 2007 A general provision of 10% on total outstanding

ii) Provision on Standard Assets UCBs were required to make a general provision of 0.25% on standard assets from the year ended March 31, 2000. The general provisioning requirement on standard assets, barring UCBs direct advance to agriculture and SME sector, was raised to 0.40% in November 2005. In order to ensure maintenance of asset quality in the context of high credit growth, RBI raised the general provisioning requirement for UCBs on standard advances in respect of personal loans, loans and advances qualifying as capital market exposure and commercial real estate loans from 0.40% to 1.0% in June 2006. Certain categories of loans continued to experience high growth; personal loans witnessed a higher default rate. Therefore, provisioning requirement in respect of personal loans, loans and advances qualifying as capital market exposure and commercial real estate loans (excluding residential housing loans) was raised from 1% to 2% in February 2007. Simultaneously, RBI decided to increase provisioning for loans and advances to Non-Deposit Taking Systematically Important Non-Banking Finance Companies (NBFC-ND-SI) from 0.40% to 2% (A systematically important NBFC is defined as an Non-Deposit Taking NBFC with an

asset size of Rs.100.00 crore or more as per the last audited balance sheet). The standard asset provisioning requirements for UCBs, after the above changes, stand as summarized below: Sr. Category of standard asset No. (a) Direct loans to agriculture and SME sectors (b) Personal loans, loans qualifying as capital market exposure, commercial real estate loans (excluding residential housing loans) and loans and advances to NBFC-ND-SI (c) All other loans and advances not included under (a) and (b) above Provisioning percentage 0.25% 2.00%

0.40%

The provision towards standard assets need not be netted from gross advances but should be shown separately as Contingent Provision towards Standard Assets under Other Funds and Reserves in the Balance Sheet. In case a bank is having provision in excess of what is required for non-performing assets under Bad & Doubtful Debt Reserve (BDDR), additional provision required for standard assets may be segregated from BDDR and parked under Contingent Provision towards Standard Assets with the approval of the Board of Directors. This contingent provision will be available for inclusion in Tier II capital. (iii) Guidelines for Provisions

1.

a)

Advances covered by DICGC / ECGC guarantee

In respect of advances guaranteed by ECGC/DICGC, provisioning is to be made only for the balance exceeding the amount of guarantee. Further, while arriving at the provision for Doubtful assets, realisable value of the securities should be deducted from the outstanding balance before the guarantee is set off.

1.

b)

Additional facilities under rehabilitation package

If under a rehabilitation package approved by BIFR / term lending institution, banks allow additional credit facilities to a unit, which has been categorised as sub-standard or doubtful, they need not make provisions for a period of one year from the date of disbursement of such additional facilities. Similar treatment should be made in respect of sick SSI units under a nursing programme. However, banks should make provisions on existing credit facilities classified as substandard or doubtful in both the cases.

1.

c)

Certain advances exempted

Advances against banks own term deposits, NSCs, KVPs, IVPs and life policies are exempted from provisioning requirements. However, advances against gold ornaments, government securities and all other securities attract provisioning.

1.

d)

Valuation of security

To have uniform assessment of valuation of security and reduce divergence in provisioning requirements, banks should undertake annual stock audit of current assets by external agencies in respect of NPAs with balance of Rs.10.00 lakh and above. Besides, immoveable property charged to the bank should be valued once in three years by the banks approved valuers. ANNEX

Relaxed Prudential Norms on Asset Classification and Provisioning for certain categories of UCBs Unit banks i.e. banks having a single branch / Head Office with deposits up to Rs.100 crore and banks having more than one branch within a single district with deposits up to Rs.100 crore are exempted from the extant asset classification and provisioning norms as under: Sr. No. 1. Extant Norm Relaxed Norm Remarks

Asset classification norm: i) With effect from the year ended March 31, 2004 the norm for classification on an asset as NPA has been reduced to 90 days from 180 days ii) With effect from the year ended March 31, 2005 an asset would be classified as doubtful if it remained in the sub-standard category for 12 months Provisioning norms i) General provisioning requirement on standard assets (excepting direct agriculture and SME) raised from 0.25% to 0.40% and to 2% on specific sectors ii) 100% provisioning on secured portion of advances classified as Doubtful III on or after April 1, 2007

These banks will continue to The 180-day delinquency identify NPAs based on 180- norm for NPAs has since day delinquency norm for been extended by one three more years commencing more year i.e. up to March March 31, 2005, i.e. up to 31, 2008. March 31, 2007. A sub-standard account will The 12-month period for continue to be classified as classification of a subdoubtful after 18 months standard asset in doubtful instead of 12 months up to category has since been March 31, 2007. extended by one more year i.e. up to March 31, 2008. General provisioning requirement on standard assets continue to remain at 0.25% for the exempted banks.

2.

100% provisioning to be made by the exempted banks on secured portion of advances classified as Doubtful III on or after April 1, 2010. iii) For the outstanding stock For the outstanding stock of of D-III advancesas on D-III advances as on March March 31, 2007 banks would 31, 2010 the exempted banks be required to provide as would be required to provide under: as under: 50% up to March 31, 2007 60% as on March 31, 2008 75% as on March 31, 2009 50% up to March 31, 2010 60% as on March 31, 2011 75% as on March 31, 2012

100% as on March 31, 2010 100% as on March 31, 2013

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