NPA classification norms significantly tightened

Daily NPA determination, full payment to move back to standard among several measures

– Anita Baid, anita@vinodkothari.com

RBI has issued a notification on Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances – Clarifications (‘RBI Circular’). The said RBI Circular dated November 12, 2021 is depicted to be a clarification issued by the RBI on the applicable prudential norms for all lending institutions. However, the same would have a major impact on the NPA classification by banks and NBFCs, specifically. The intention of the RBI is to clarify and harmonise certain aspects of the extant regulatory guidelines, making it applicable mutatis mutandis to all lending institutions

We are organising a Workshop to discuss the intricacies and impact of the RBI Circular on Saturday, November 20, 2021 at 11:30am. The participation is on an invite basis only. Kindly register your interest here

The major clarifications are applicable on the lenders with immediate effect and hence, it becomes important to understand the changes and its impact.

Highlights of the clarifications:

  1. Specification of exact due dates for repayment of a loan, frequency of repayment, breakup between principal and interest, examples of SMA/NPA classification dates, etc. in the loan agreement-  to be complied with by December 31, 2021 for new loans, and at the time of renewal/review for existing loans;
  2. The timelines for SMA categorisation has been modified to ensure that the same is continuous. Earlier the overdue timeline for SMA 0, SMA 1 and SMA 2 was 1-30, 31-60 and 61-90 days respective. Now the same shall be upto 30, more than 30 upto 60 and more than 60 upto 90 days–  applicable immediately;
  3. Classification of borrower accounts as SMA as well as NPA shall be done as part of the day-end process for the relevant date and the SMA or NPA classification date shall be the calendar date for which the day end process is run. The said SMA classification of borrower accounts are applicable to all loans (except agri advances), including retail loans, irrespective of size of exposure of the lending institution-  applicable immediately;
  4. Term loan accounts will be classified as NPA if the interest applied at specified rests remains overdue for more than 90 days, this is an amendment to IRACP norms applicable to banks for classification of NPA and there is no change for NBFCs since they have already been classifying such accounts as NPA in case the instalment is overdue for a period of 3 months or more or on which interest amount remained overdue for a period of 3 months or moreapplicable for loan accounts becoming overdue on or after March 31, 2022;
  5. Loan accounts classified as NPAs may be upgraded as ‘standard’ assets only if entire arrears of interest and principal are paid by the borrower- applicable immediately;
  6. In cases of loans where moratorium has been granted for repayment of interest, lending institutions may recognize interest income on accrual basis for accounts which continue to be classified as ‘standard’- applicable immediately;
  7. If loans with moratorium on payment of interest (permitted at the time of sanction of the loan) become NPA after the moratorium period is over, the capitalized interest corresponding to the interest accrued during such moratorium period need not be reversed- applicable immediately;
  8. Lending institutions shall place consumer education literature on their websites, explaining with examples, the concepts of date of overdue, SMA and NPA classification and upgradation, with specific reference to day-end process- to be complied with by March 31, 2022.

NPA Classification and Reporting

Before getting into the exact contents of the RBI Circular, let us first understand the existing process of NPA classification and provisioning.

For banks and NBFCs[1], loan account is classified as an NPA if the interest or principal remains overdue for a period 90 days or three months and above. Standard Asset means an asset in respect of which, no default in repayment of principal or payment of interest is perceived and which does not disclose any problem or carry more than normal risk attached to the business. The usual practice among the NBFCs has been that once an asset is classified as NPA, it will move back to ‘Standard’ category if the DPD (days past due) count comes below 90 days. Now the reporting of NPA is done at the month or quarter end and hence, the fluctuations during the particular month or quarter is not considered. It is only based on the position of the loan account as on the reporting date, the classification is done.

However, the RBI has now clarified that borrower accounts shall be flagged as overdue by the lending institutions as part of their day-end processes for the due date, irrespective of the time of running such processes. Further, the classification of borrower accounts as SMA or NPA shall also be done as part of the day-end process for the relevant date. In other words, the SMA or NPA classification date shall be the calendar date for which the day end process is run.

It is important to note that the RBI Circular states that NPA classification shall be based on the account being overdue for more than 90 days which at present is considered as 90 days and above. However, the implications of day count run would outweigh the 1 day relaxation in NPA classification.

 

Let us understand taking November 15, 2021 as the due date –

DPD Status as on 15th November Classification as on the day end Classification as on the Reporting Date, i.e. 30th November
1-30 days SMA 0 To be reported as per the day end process

 

Upgraded to Standard only if the entire outstanding is repaid

31-60 days SMA 1
61- 90 days SMA 2
More than 90 days NPA

DPD status and NPA classification will no longer be correlated. An account classified as NPA would continue as the same even if one or two installments have been paid. Hence, even at a DPD of less than 90 days, the account still would be classified as NPA. Further, the provisioning will also be done accordingly- depending on the classification as on the date of the creating such provision.

There may also be an impact on the P/L of the lender. Since, once the account turns NPA, the income recognition is on a cash basis under RBI norms. This will continue until the entire dues are repaid by the customer. Hence, the delay in upgradation would eventually keep the income recognition on a cash basis.

Counting of DPD based on Due Date

It must be noted that the counting is not based on three repayment installments falling due, instead the oldest of the payment due date shall be considered and the number of days falling due shall be counted to classify the loan account as NPA. In this regard, in case the due date and billing date are different, the former would be considered for the purpose of calculating the DPD. The same-day default classification would increase the operational burden on the lenders, since they would be required to monitor the payment and resultant classification on a daily basis.

Receipt of Payment Instrument

There could be a situation wherein the payments instrument (cheque) has been collected from the borrower but the same is pending for clearance or has not been deposited in the bank- in such a case, the question would be whether the classification be done on the basis of receipt of the payment instrument or the actual collection in the bank account. It would be unfair to degrade the classification of the borrower if the payment instrument has been submitted by the borrower, however, treating the acceptance as clearance could be a practice that the lender may misuse. Hence, it is prudent to treat only the actual collection of repayment as sufficient discharge of payment obligation by the borrower.

Applicability for different categories of NBFCs

The intent of the RBI Circular is to bring the classification norms of NBFCs at par with banks. However, there are certain categories of NBFCs that in the first place are either not covered under certain aspects of the IRAC provisions or have less stringent norms applicable on them. For instance, Housing Finance Companies (HFCs), which are now a category of NBFCs, are not required to do SMA classification and report to CRILC. Hence, the clarification for SMA classification should ideally not be made applicable on HFCs by virtue of the RBI Circular. However, it is prudent to ensure that the SMA classification is being done by the HFC, though the same may not be reported to CRILC. It seems that eventually, the RBI may extend the CRILC reporting to HFCs as well. 

Similarly, NBFC-NSIs at present follow the DPD count of 180 days for classification as NPA. Since the 90-days NPA norm is to be implemented in a phased manner by NBFC-NSI as per the Scale Based Regulatory Framework, the provisions of the RBI Circular shall apply accordingly. Hence, even NBFC-NSI will have to implement the day count run immediately but the DPD count for classification as NPA would be as per the relaxation provided by RBI.

Upgradation of NPA accounts

As discussed, the approach of the lending institutions for upgrading accounts classified as NPAs to ‘standard’ asset category upon payment of only interest overdues, partial overdues, etc. or upon the DPD status coming below 90 days. However, the RBI has clarified that loan accounts classified as NPAs may be upgraded as ‘standard’ assets only if entire arrears of interest and principal are paid by the borrower. This would mean that any partial payment, such as payment of only interest or only one installment, shall not result in the upgradation of the loan account.

Hence, once a loan account is classified as an NPA, it shall remain as such till the time the entire outstanding amount is repaid. Hence, there would be no downgrade from NPA to SMA- it can only directly be classified as 0 DPD.

Considering penal Interest and other charges

In case of a situation where the borrower clears all his dues except the overdues and penal interest etc.- Will the account be upgraded to a standard category or will it remain as an NPA. The usual practice is that these payments take priority and have to be adjusted first from the collections received. Here, it is important to understand that penal interest and other charges are accounted for on cash basis and they will not be classified as overdue instead be recognised only when collected. Hence, even if the charges remain unpaid, but all other outstanding payments are received the account would be upgraded as standard. 

This clause is effective with immediate effect, hence, there will be no impact on the loan accounts that have already been rolled back and are classified as standard as on November 12, 2021. The loan account that reaches more than 90 days after November 12 will be classified as NPA and remains as such until the borrower clears all the dues.

It is very likely that the tightening of upgradation criteria could result in an increase in the NPA count for NBFCs specifically, since banks were already following the same.

Impact on Ind AS Accounting

NPA recognition is a regulatory requirement, the same does not directly have an impact on the credit risk associated with the loan account.  Hence, Ind AS reporting may not have any impact due to the RBI classification. There is no necessary correlation between the credit-impaired status under Ind AS and the asset classification under regulatory norms. As per the past practice, there remains a gap between IRAC and Ind AS, if regulators still insist, the asset will continue as NPA even if it goes below 90- the same is not unusual. Like provisioning is different under IRAC and IndAS, the same would still continue. 

We are further analysing the provisions and shall keep updating the article.

 

[1] At present the 90 days norm is for NBFC-SI, however, the Scale Based Regulations (SBR) proposes to align the same for NBFC-NSI as well

10 replies
  1. Vinod Kothari
    Vinod Kothari says:

    What is the relevance of Para 8 of the Circular which makes an amendment in para 2.1.3 of the IRACP Directions? This seems to be applicable only after 31st March, 2022. Is this applicable to NBFCs?

    Reply
    • Anita Baid
      Anita Baid says:

      Term loan accounts will be classified as NPA if the interest applied at specified rests remains overdue for more than 90 days, this is an amendment to IRACP norms applicable to banks for classification of NPA and there is no change for NBFCs since they have already been classifying such accounts as NPA in case the installment is overdue for a period of 3 months or more or on which interest amount remained overdue for a period of 3 months or more

      Reply
  2. Mohit Kumar Jain
    Mohit Kumar Jain says:

    Hi just want to know that a customer paying his emi on monthly basis but delaying 10 days every month due to this his 4 months penalty interest accumulated as on 30 sep-21..but pending emi amount is nil..should we consider that loan account also NPA

    Reply
  3. Kwinkle Maliwal
    Kwinkle Maliwal says:

    Hi,

    As per the IRCAP, SMA classification in applicable immediately. In such case, an account will be considered NPA if DPD is 90+. However in SBR, 90-days NPA norm is to be implemented in phased manner.

    Please advise- What impact does these guidelines have on NBFCs-NSI? What shall be done to abide by both notifications as an NBFC?

    Thank you.

    Reply
    • Anita Baid
      Anita Baid says:

      Since the 90-days NPA norm is to be implemented in a phased manner by NBFC-NSI as per the Scale Based Regulatory Framework, the provisions of the RBI Circular shall apply accordingly. Hence, even NBFC-NSI will have to implement the day count run immediately but, the DPD count for classification as NPA would be as per the relaxation provided by RBI.

      Reply

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