RBI/2009-10/93
UBD.PCB.MC.No. 3 / 09.14.000 / 2009-10

July 1, 2009

The Chief Executive Officers of
All Primary (Urban) Co-operative Banks

Dear Sir / Madam,

Master Circular on Income Recognition, Asset
Classification, Provisioning & Other Related Matters - UCBs

Please refer to our Master Circular UBD.PCB.MC.No. 3 / 09.14.000 / 2008-09 dated July 1, 2008 on the captioned subject. The enclosed Master Circular consolidates and updates all the instructions / guidelines issued on the subject up to June 30, 2009.

Yours faithfully,

(A.K Khound)
Chief General Manager-in-Charge

Encl: As above.

Master Circular on Income Recognition, Asset
Classification, Provisioning & Other Related Matters-

1. GENERAL

1.1 In order to reflect a bank's actual financial health in its balance sheet and as per the recommendations made by the Committee on Financial System (Chairman Shri M. Narasimham), the Reserve Bank has introduced, in a phased manner, prudential norms for income recognition, asset classification and provisioning for the advances portfolio of the banks.

1.2  Broadly, the policy of income recognition should be objective and based on record of recovery rather than on any subjective considerations. Likewise, the classification of assets of banks has to be done on the basis of objective criteria, which would ensure a uniform and consistent application of the norms. The provisioning should be made on the basis of the classification of assets into different categories.

1.3 The requirements of the State Co-operative Societies Acts and / or  rules made thereunder or other statutory enactments may continue to be followed, if they are more stringent than those prescribed hereby.

1.4 With the introduction of prudential norms, the Health Code based system for classification of advances has ceased to be a subject of supervisory interest. As such, all related reporting requirements, etc. also ceased to be a supervisory requirement, but could be continued in the banks entirely at their discretion and the management policy, if felt necessary.

2. NON-PERFORMING ASSETS (NPA)

2.1 Classification of Assets as Non-Performing

2.1.1  An asset becomes non-performing when it ceases to generate income for the bank. Earlier an asset was considered as non-performing asset (NPA) based on the concept of 'Past Due'. A ‘non performing asset’ (NPA) was defined as credit in respect of which interest and/ or installment of principal has remained ‘past due’ for a specific period of time. The specific period was reduced in a phased manner as under:

An amount is considered as past due, when it remains outstanding for 30 days beyond the due date. However, with effect from March 31, 2001 the ‘past due’ concept has been dispensed with and the period is reckoned from the due date of payment. 
          
2.1.2 With a view to moving towards international best practices and to ensure greater transparency, '90 days' overdue* norms for identification of NPAs have been made applicable from the year ended March 31, 2004. As such, with effect from March 31, 2004, a non-performing asset shall be a loan or an advance where:

(i) Interest and/or installment of principal remain overdue for a period of more than 90 days in respect of a Term Loan.
(ii) The account remains 'Out of order'@ for a period of more than 90 days, in respect of an Overdraft/ Cash Credit (OD/CC).
(iii) The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted,
(iv) In the case of direct agricultural advances as listed in Annex 1, the overdue norm specified at para 2.1.5 would be applicable. In respect of agricultural loans, other than those specified in Annex 1, identification of NPAs would be done on the same basis as non-agricultural advances.
(v)  Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.

* Any amount due to the bank under any credit facility, if not paid by the due date fixed by the bank becomes overdue.

@ “An account should be treated as 'out of order' if the outstanding balance remains continuously in excess of the sanctioned limit / drawing power.  In cases where the outstanding balance in the principal operating account is less than the sanctioned limit/drawing power, but there are no credits continuously for 90 days or credits are not enough to cover the interest debited during the same period, these accounts should be treated as 'out of order'”.

2.1.3 Tier I Banks ( for definition please see annex 4) were permitted to classify loan accounts including gold loans and  small loan upto Rs 1 lakh as NPAs based on 180 days delinquency norm instead of the extant 90 days norm. This relaxation was in force upto March 31, 2009. For the above category of banks, an account would be classified as Non Performing Asset if the :     

(i) Interest and/or installment of principal remain overdue for a period of more than 180 days in respect of a Term Loan.
(ii) The account remains 'Out of order' for a period of more than 180 days, in respect of an Overdraft/Cash Credit (OD/CC).
(iii) The bill remains overdue for a period of more than 180 days, in the case of bills purchased and discounted.
(iv) Any amount to be received remains overdue for a period of more than 180 days in respect of other accounts.

The relaxations were given for the explicit purpose of enabling the UCBs concerned to transit to the 90 day NPA norm in the year 2009-10 by building up adequate provisions and strengthening their appraisal, disbursement and post disbursement procedures.

2.1.4  Tier II banks shall classify their loan accounts as NPA as per 90  day norm as hitherto.

Note : A comparative analysis of the prudential norms as applicable for Tier I and Tier II banks are given in the Annex 4.

2.1.5 Agricultural Advance:

(i)  With effect from September 30, 2004 the following revised norms are applicable to all direct agricultural advances (Annex 1):

a) A loan granted for short duration crops will be treated as NPA, if the installment of principal or interest thereon remains overdue for two crop seasons.

b) A loan granted for long duration crops will be treated as NPA, if the installment of principal or interest thereon remains overdue for one crop season.

(ii) For the purpose of these guidelines, "long duration" crops would be crops with crop season longer than one year and crops, which are not "long duration" crops would be treated as "short duration" crops.

(iii)  The crop season for each crop, which means the period up to harvesting of the crops raised, would be as determined by the State Level Bankers' Committee in each state.

(iv) Depending upon the duration of crops raised by an agriculturist, the above NPA norms would also be made applicable to agricultural term loans availed of by him. In respect of agricultural loans, other than those specified in the Annex 1 and term loans given to non-agriculturists, identification of NPAs would be done on the same basis as non-agricultural advances, which, at present, is the 90 days delinquency norm.

(v) Banks should ensure that while granting loans and advances, realistic repayment schedules are fixed on the basis of cash flows / fluidity with the borrowers.

2.1.6  Identification of assets as NPAs should be done on an ongoing basis

The system should ensure that identification of NPAs is done on an on-going basis and doubts in asset classification due to any reason are settled through specified internal channels within one month from the date on which the account would have been classified as NPA as per prescribed norms. Banks should also make provisions for NPAs as at the end of each calendar quarter i.e as at the end of March/ June/ September/ December, so that the income and expenditure account for the respective quarters as well as the P&L account and balance sheet for the year end reflects the provision made for NPAs.

2.1.7   Charging of interest at monthly rests

(i) Banks should charge interest at monthly rests in the context of adoption of 90 days norm for recognition of loan impairment w.e.f. from the year ended March 31, 2004 and consequential need for close monitoring of borrowers' accounts. However, the date of classification of an advance as NPA as stated in preceding paras, should not be changed on account of charging of interest at monthly basis.

(ii) The existing practice of charging /compounding of interest on agricultural advances would be linked to crop seasons and the instructions regarding charging of interest on monthly rests shall not be applicable to agricultural advances.

(iii) While compounding interest at monthly rests effective from April 1, 2003, banks should ensure that in respect of advances where administered interest rates are applicable, they should re-align the rates suitably keeping in view the minimum lending rate charged by the bank (in view of the freedom given to them for fixing lending rates) so that they comply with the same. In all other cases also, banks should ensure that the effective rate does not go up merely on account of the switchover to the system of charging interest on monthly rests.

(iv) Banks should take into consideration due date/s fixed on the basis of fluidity with borrowers and harvesting/ marketing season while charging interest and compound the same if the loan/ installment becomes overdue in respect of short duration crops and allied agricultural activities.

2.2  Treatment of Accounts as NPAs

2.2.1 Record of Recovery

(i) The treatment of an asset as NPA should be based on the record of recovery. Banks should not treat an advance as NPA merely due to existence of some deficiencies which are of temporary in nature such as non-availability of adequate drawing power, balance outstanding exceeding the limit, non-submission of stock statements and the non-renewal of the limits on the due date, etc.  Where there is a threat of loss, or the recoverability of the advances is in doubt, the asset should be treated as NPA.

(ii)  A credit facility should be treated as NPA as per norms given in paragraph 2.1 above.  However, where the accounts of the borrowers have been regularised by repayment of overdue amounts through genuine sources (not by sanction of additional facilities or transfer of funds between accounts), the accounts need not be treated as NPAs. In such cases, it should, however, be ensured that the accounts remain in order subsequently and a solitary credit entry made in an account on or before the balance sheet date which extinguishes the overdue amount of interest or installment of principal is not reckoned as the sole criteria for treatment the account as a standard asset.

2.2.2 Treatment of NPAs – Borrower-wise and not Facility-wise

(i) In respect of a borrower having more than one facility with a bank, all the facilities granted by the bank will have to be treated as NPA and not the particular facility or part thereof which has become irregular.

(ii) However, in respect of consortium advances or financing under multiple banking arrangements, each bank may classify the borrowal accounts according to its own record of recovery and other aspects having a bearing on the recoverability of the advances.

2.2.3 Agricultural Advances – Default in repayment due to natural calamities

(i) Where natural calamities impair the repaying capacity of agricultural borrowers, as a relief measure, banks may decide on their own to:

a) convert the short-term production loan into a term loan or re-schedule the repayment period, and

b) sanction fresh short-term loans

(ii)  In such cases of conversion or re-schedulement, the term loan as well as fresh short-term loan may be treated as current dues and need not be classified as non performing asset (NPA). The asset classification of these loans would, therefore, be governed by the revised terms and conditions and these would be treated as NPA under the extant norms applicable for classifying agricultural advances as NPAs. 

2.2.4   Housing Loan to Staff

In the case of housing loan or similar advances granted to staff members where interest is payable after recovery of principal, interest need not be considered as overdue from the first quarter onwards. Such loans/ advances should be classified as NPA only when there is a default in repayment of instalment of principal or payment of interest on the respective due dates.

2.2.5  Credit facilities Guaranteed by Central /State Government

(i) The credit  facilities  backed by  guarantee  of  the Central Government though overdue should not be treated as NPA

(ii) This exemption from classification of government guaranteed advances as NPA is not for the purpose of recognition of income
.
(iii) From the year ended March 31, 2006, State Government guaranteed advance and investment in State Government guaranteed securities would attract asset classification and provisioning norms, if interest and/or principal or any other amount due to the bank remains overdue for more than 90 days irrespective of the fact whether the guarantee have been invoked or not.

2.2.6   Project Financing

In the case of bank finance given for industrial projects where moratorium is available for payment of interest, payment of interest becomes due only after the moratorium or gestation period is over. Therefore, such amounts of interest do not become overdue and hence NPA, with reference to the date of debit of interest.  They become overdue after due date for payment of interest, if uncollected.

2.2.7 Prudential Guidelines on Restructuring of Advances

The prudential guidelines on restructuring of advances are detailed as under:

(a)  Asset classification norms

2.2.7.1  Restructuring of advances could take place in the following stages :

(a) before commencement of commercial production / operation;
(b) after commencement of commercial production / operation but before the asset has been classified as 'sub-standard';
(c) after commencement of commercial production / operation and the asset has been classified as 'sub-standard' or 'doubtful'.

2.2.7.2   The accounts classified as 'standard assets' should be immediately re-classified as 'sub-standard assets' upon restructuring.

2.2.7.3   The non performing assets, upon restructuring, would slip into further lower asset classification category as per extant asset classification norms with reference to the pre-restructuring repayment schedule.

2.2.7.4   All restructured accounts which have been classified as non-performing assets upon restructuring, would be eligible for up-gradation to the 'standard' category after observation of 'satisfactory performance' during the 'specified period' (Annex-VII).

2.2.7.5    In case, however, satisfactory performance after the specified 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.

2.2.7.6   Any additional finance may be treated as 'standard asset', up to a period of one year after the first interest / principal payment, whichever is earlier, falls due under the approved restructuring package. However, in the case of accounts where the prerestructuring facilities were classified as 'sub-standard' and 'doubtful', interest income on the additional finance should be recognised only on cash basis. If the restructured asset does not qualify for upgradation at the end of the above specified one year period, the additional finance shall be placed in the same asset classification category as the restructured debt.

2.2.7.7   In respect of loan accounts which enjoy special regulatory treatment as per para 2.2.7.25, upon restructuring, such non-performing assets would continue to have the same asset classification as prior to restructuring.  In case satisfactory performance of the account is not evidenced during the ‘specified period’, it would slip into further lower asset classification categories as per extant asset classification norms with reference to the pre-restructuring repayment schedule.

2.2.7.8   In case a restructured asset, which is a standard asset on restructuring, is subjected to restructuring on a subsequent occasion, it should be classified as substandard. If the restructured asset is a sub-standard or a doubtful asset and is subjected to restructuring, on a subsequent occasion, its asset classification will be reckoned from the date when it became NPA on the first occasion. However, such advances restructured on second or more occasion may be allowed to be upgraded to standard category after one year from the date of first payment of interest or repayment of principal whichever falls due earlier in terms of the current restructuring package subject to satisfactory performance.

(b)  Income recognition norms

2.2.7.9    Subject to provisions of paragraphs 2.2.7.6 and 2.2.7.22 interest income in respect of restructured accounts classified as ‘standard assets’ will be recognized on accrual basis and that in respect of the account classified as ‘non performing assets’ will be recognized on cash basis.

(c)   Provisioning norms 2.2.7.10. Normal provisions

Banks will hold provision against the restructured advances as per the existing provisioning norms.

2.2.7.11.Provision for diminution in the fair value of restructured Advances

The erosion in the fair value of the advance should be computed as the difference between the fair value of the loan before and after restructuring. Fair value of the loan before restructuring will be computed as the present value of cash flows representing the interest at the existing rate charged on the advance before restructuring and the principal, discounted at a rate equal to the bank’s BPLR as on the date of restructuring plus the appropriate term premium and credit risk premium for the borrower category on the date of restructuring". Fair value of the loan after restructuring will be computed as the present value of cash flows representing the interest at the rate charged on the advance on restructuring and the principal, discounted at a rate equal to the bank’s BPLR as on the date of restructuring plus the appropriate term premium and credit risk premium for the borrower category on the date of restructuring".

2.2.7.12.   It may please be noted that the above formula moderates the swing in the diminution of present value of loans with the interest rate cycle and will have to be followed consistently in future. No request for changing the same, particularly for reversion to the present formula, will be entertained in future.

2.2.7.13.  Further, it is reiterated that the provisions required as above arise due to the action of the banks resulting in change in contractual terms of the loan upon restructuring which are in the nature of financial concessions. These provisions are distinct from the provisions which are linked to the asset classification of the account classified as NPA and reflect the impairment due to deterioration in the credit quality of the loan. Thus, the two types of the provisions are not substitute for each other.

2.2.7.14.  It is also re-emphasised that the modifications effected to the guidelines on restructuring of advances by RBI are aimed at providing an opportunity to banks and borrowers to preserve the economic value of the units and should not be looked at as a means to evergreen the advances.

2.2.7.15. In their published annual Balance Sheets for the year ending March 2009, in addition to the disclosures regarding restructured loans required in terms of paragraph 9 of the guidelines enclosed to circular dated March 6, 2009, banks should also disclose the amount and number of accounts in respect of which applications for restructuring are under process, but the restructuring packages have not yet been approved.

2.2.7.16   In the case of working capital facilities, the diminution in the fair value of the cash credit / overdraft component may be computed as indicated in para 2.2.7.11 above, reckoning the higher of the outstanding amount or the limit sanctioned as the principal amount and taking the tenor of the advance as one year. The term premium in the discount factor would be as applicable for one year. The fair value of the term loan components (Working Capital Term Loan and Funded Interest Term Loan) would be computed as per actual cash flows and taking the term premium in the discount factor as applicable for the maturity of the respective term loan components.

2.2.7.17   In the event any security is taken in lieu of the diminution in the fair value of the advance, it should be valued at Re.1/- till maturity of the security. This will ensure that the effect of charging off the economic sacrifice to the Profit & Loss account is not negated.

2.2.7.18    The diminution in the fair value may be re-computed on each balance sheet date till satisfactory completion of all repayment obligations and full repayment of the outstanding in the account, so as to capture the changes in the fair value on account of changes in BPLR, term premium and the credit category of the borrower. Consequently, banks may provide for the shortfall in provision or reverse the amount of excess provision held in the distinct account.

2.2.7.19   If due to lack of expertise / appropriate infrastructure, a bank finds it difficult to ensure computation of diminution in the fair value of advances extended by small branches, as an alternative to the methodology prescribed above for computing the amount of diminution in the fair value, banks will have the option of notionally computing the amount of diminution in the fair value and providing therefor, at five percent of the total exposure, in respect of all restructured accounts where the total dues to bank(s) are less than rupees one crore till the financial year ending March 2011. The position would be reviewed thereafter.

2.2.7.20.   The total provisions required against an account (normal provisions plus provisions in lieu of diminution in the fair value of the advance) are capped at 100% of the outstanding debt amount.

(d)  Prudential Norms for Conversion of Unpaid Interest into 'Funded Interest Term Loan' (FITL)

2.2.7.21     Asset classification norms

The FITL created by conversion of unpaid interest will be classified in the same asset classification category in which the restructured advance has been classified. Further movement in the asset classification of FITL would also be determined based on the subsequent asset classification of the restructured advance.

2.2.7.22    Income recognition norms

(i) The income, if any, generated may be recognised on accrual basis, if FITL is classified as 'standard', and on cash basis in the cases where the same has been classified as a non-performing asset.

(ii) The unrealised income represented by FITL should have a corresponding credit in an account styled as "Sundry Liabilities Account (Interest Capitalization)".

(iii) Only on repayment in case of FITL, the amount received will be recognized in the P&L Account, while simultaneously reducing the balance in the "Sundry Liabilities Account (Interest Capitalisation)".

(e)  Special Regulatory Treatment for Asset Classification

2.2.7.23 The special regulatory treatment for asset classification, in modification to the provisions in this regard stipulated in para 2.2.7.1 to 2.2.7.8, will be available to the borrowers engaged in important business activities, subject to compliance with certain conditions as enumerated in para 2.2.7.29 below. Such treatment is not extended to the following categories of advances :

(i) Consumer and personal advances including advances to individuals against the securities of shares/bonds/debentures etc

(ii) Advances to traders

2.2.7.24  The asset classification of the above two categories of accounts as well as that of other accounts which do not comply with the conditions enumerated in para 2.2.7.29, will be governed by the prudential norms in this regard described in para 2.2.7.1 to 2.2.7.8 above.

2.2.7.25   As real estate sector is facing difficulties, it has been decided to extend special regulatory treatment to commercial real estate exposures, which are restructured up to June 30, 2009.  Further, housing loans granted by banks would also be eligible for special regulatory treatment, if restructured. 

(f)  Elements of special regulatory framework

2.2.7.26  The special regulatory treatment has the following three components :

(i) Incentive for quick implementation of the restructuring package.

(ii) Retention of the asset classification of the restructured account in the pre restructuring asset classification category

2.2.7.27  Incentive for quick implementation of the restructuring package

During the pendency of the application for restructuring of the advance with the bank, the usual asset classification norms would continue to apply. The process of reclassification of an asset should not stop merely because the application is under consideration. However, as an incentive for quick implementation of the package, if the approved package is implemented by the bank within 120 days from the date of receipt of application by the bank, the asset classification status may be restored to the position which existed when the restructuring application was received by the bank:  Further, all accounts which were standard accounts as on September 1, 2008 would be treated as standard accounts on restructuring provided the restructuring package is put in place within 120 days from the date of taking up the restructuring package. The 120 days norm for quick implementation of the restructuring package would stand reduced to 90 days in respect of all restructuring packages implemented after June 30, 2009.

2.2.7.28  Asset classification benefits

Subject to the compliance with the undernoted conditions in addition to the adherence to the prudential framework laid down in para 2.2.7.1 to 2.2.7.8:

(i) In modification to para 2.2.7.2, an existing 'standard asset' will not be downgraded to the sub-standard category upon restructuring.

(ii) In modification to para 2.2.7.3 during the specified period, the asset classification of the sub-standard / doubtful accounts will not deteriorate upon restructuring, if satisfactory performance is demonstrated during the specified period.

2.2.7.29  However, these benefits will be available subject to compliance with the following conditions:

i) The dues to the bank are 'fully secured' as defined in Annex VII. The condition of being fully secured by tangible security will not be applicable in the following cases:

(a) SSI borrowers, where the outstanding is up to Rs.25 lakh.

(b) infrastructure projects, provided the cash flows generated from these projects are adequate for repayment of the advance, the financing bank(s) have in place an appropriate mechanism to escrow the cash flows, and also have a clear and legal first claim on these cash flows.

(c) The value of security is relevant to determine the likely losses which a bank might suffer on the exposure should the default take place.  This aspect assumes greater importance in the case of restructured loans.  However, owing to the current downturn, the full security cover for the WCTL created by conversion of the irregular portion of principal dues over the drawing power, may not be available due to fall in the prices of security such as inventories.  In view of the extraordinary situation, this special regulatory treatment is available to ‘standard’ and ‘sub standard accounts’ even where full security cover for WCTL is not available, subject to the condition that provisions are made against the unsecured portion of the WCTL, as under:

• Standard Assets : 20%
• Substandard Assets: 20% during the first  year and to be increased by 20% every year thereafter until the specified period (one year after the first payment is due under the terms of restructuring)
• If the account is not eligible for upgradation after the specified period, the unsecured portion will attract provision of 100%

ii) The unit becomes viable in 10 years, if it is engaged in infrastructure activities, and in 7 years in the case of other units.

iii) The repayment period of the restructured advance including the moratorium, if any, does not exceed 15 years in the case of infrastructure advances and 10 years in the case of other advances.  However the ceiling of 10 years would not apply in case of housing loans and the Board of Directors of the banks should prescribe the maximum period not exceeding 15 years for restructured advances keeping in view the safety and soundness of advances.

(iv) The restructured housing loans would be assigned additional risk weight of 25 percentage points over the prescribed risk weights.

iv) Promoters' sacrifice and additional funds brought by them should be a minimum of 15% of banks' sacrifice.

v) Personal guarantee is offered by the promoter except when the unit is affected by external factors pertaining to the economy and industry.

vi) The restructuring under consideration is not a 'repeated restructuring' as defined in para (iv) of Annex VII.   However, as a one time measure, second restructuring carried out by banks of exposures (other than commercial real estate, capital market exposures, personal/consumer loans and loans to traders) upto June 30, 2009 shall be eligible for special regulatory treatment. 

(g) Disclosures

2.27.30    Banks should disclose in their published annual Balance Sheets, under ‘Notes on Accounts’, information relating to number and amount of advances restructured and the amount of diminution in the fair value of the restructured advances in Annex-VIII. 

(h) Illustrations

2.2.7.31   A few illustrations on the asset classification of restructured accounts are given in Annex-IX.

2.2.8   Other Advances

(i) Advances against term deposits, NSCs eligible for surrender, IVPs, KVPs and Life policies need not be treated as NPAs although interest thereon may not have been paid for more than 90 days provided adequate margin is available in the accounts.

(ii) Banks should fix monthly/quarterly instalments for repayment of gold loans for non-agricultural purposes taking into account the pattern of income generation and repayment capacity of the borrowers and such gold loan accounts may be treated as NPAs if instalments of principal and/ or interest thereon are overdue for more than 90 days.

(iii) As regards gold loans granted for agricultural purposes, interest is required to be charged as per Supreme Court judgement at yearly intervals and payment should coincide with the harvesting of crops.  Accordingly, such advances will be treated as NPA only if instalments of principal and/or interest become overdue after due date.

2.2.9   Recognition of Income on Investment Treated as NPAs

The investments are also subject to the prudential norms on income recognition.  Banks should not book income on accrual basis in respect of any security irrespective of the category in which    it is included, where the interest/principal is in arrears for more than 90 days .

2.2.10 NPA Reporting to Reserve Bank

Banks should report the figures of NPAs to the Regional Office of the Reserve Bank at the end of each year within two months from the close of the year in the prescribed proforma given in the Annex 2.

3  ASSET CLASSIFICATION

3.1 Classification

3.1.1   Banks should classify their assets into the following broad groups, viz.

(i) Standard Assets
(ii) Sub-standard Assets
(iii) Doubtful Assets
(iv) Loss Assets

3.2 Definitions

3.2.1 Standard Assets

Standard Asset is one which does not disclose any problems and which does not carry more than normal risk attached to the business.  Such an asset should not be an NPA.

3.2.2  Sub-standard Assets

(i) With effect from March 31, 2005 an asset would be classified as sub-standard  if it remained NPA  for a period less than or equal to 12 months. In such cases, the current net worth of the borrowers/ guarantors or the current market value of the security charged is not enough to ensure recovery of the dues to the banks in full.  In other words, such assets will have well defined credit weaknesses that jeopardise the liquidation of the debt and are characterised by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.

(ii) An asset where the terms of the loan agreement regarding interest and principal have been re-negotiated or rescheduled after commencement of production, should be classified as sub-standard and should remain in such category for at least 12 months of satisfactory performance under the re-negotiated or rescheduled terms.  In other words, the classification of an asset should not be upgraded merely as a result of rescheduling, unless there is satisfactory compliance of this condition.

3.2. 3 Doubtful Assets

With effect from March 31, 2005, an asset is required to be classified as doubtful, if it has remained NPA  for more than 12 months.  For Tier I banks, the 12-month period of classification of a substandard asset in doubtful category is effective from April 1, 2009. As in the case of sub-standard assets, rescheduling does not entitle the bank to upgrade the quality of an advance automatically. A loan classified as doubtful has all the weaknesses inherent as that 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.

Note: Consequent to change in asset classification norms w.e.f. March 31, 2005 banks are permitted to phase the consequent additional provisioning over a five year period commencing from the year ended March 31, 2005, with a minimum of 10 % of the required provision in each of the first two years and the balance in equal instalments over the subsequent three years.

3.2.4 Loss Assets

A loss asset is one where loss has been identified by the bank or internal or external auditors or by the Co-operation Department or by the Reserve Bank of India inspection but the amount has not been written off, wholly or partly. In other words, such an asset is considered un-collectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.

3.3 Guidelines for Classification of Assets

3.3.1  Basic Considerations

(i) 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 realisation of dues.

(ii) In respect of accounts where there are potential threats to recovery on account of erosion in the value of security and existence of other factors such as, frauds committed by borrowers, it will not be prudent for the banks to classify them first as sub-standard and then as doubtful after expiry of 12 months from the date the account has become NPA.  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.

3.3.2   Advances Granted under Rehabilitation Packages Approved by BIFR/Term Lending Institutions
           
(i) Banks are not permitted to upgrade the classification of any  advance in respect of which the terms have been re-negotiated unless the package of re-negotiated terms has worked satisfactorily for a period of one year.  While the existing credit facilities sanctioned to a unit under rehabilitation packages approved by BIFR/term lending institutions will continue to be classified as sub-standard or doubtful as the case may be in respect of additional facilities sanctioned under the rehabilitation packages the income recognition and asset classification norms will become applicable after a period of one year from the date of disbursement.

(ii) A similar relaxation be made in respect of SSI units which are identified as sick by banks themselves and where rehabilitation packages/nursing programmes have been drawn by the banks themselves or under consortium arrangements.

3.3.3   Internal System for Classification of Assets as NPA

(i) Banks should establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of NPAs, especially in respect of high value accounts.  The banks 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.

(ii) Responsibility and validation levels for ensuring proper asset classification may be fixed by the bank.

(iii) The system should ensure that doubts in asset classification due to any reason are settled through specified internal channels within one month from the date on which the account would have been classified as NPA as per extant guidelines.

(iv) RBI would continue to identify the divergences arising due to non-compliance, for fixing accountability.  Where there is wilful non-compliance by the official responsible for classification and is well documented, RBI would initiate deterrent action including imposition of monetary penalties.

4.  INCOME RECOGNITION 

4.1 Income Recognition - Policy

4.1.1 The policy of income recognition has to be objective and based on the record of recovery.  Income from non-performing assets (NPA) is not recognised on accrual basis but is booked as income only when it is actually received.  Therefore, banks should not take to income account interest on  non-performing assets on accrual basis.

4.1.2 However, interest on advances against term deposits, NSCs, IVPs, KVPs and Life policies may be taken to income account on the due date, provided adequate margin is available in the accounts.

4.1.3  Fees and commissions earned by the banks as a result of re-negotiations or rescheduling of outstanding debts should be recognised on an accrual basis over the period of time covered by the re-negotiated or rescheduled extension of credit.

4.1.4 If Government guaranteed advances become 'overdue' and thereby NPA, the interest on such advances should not be taken to income account unless the interest has been realised.

4.2  Reversal of Income on Accounts Becoming NPAs

4.2.1 If any advance including bills purchased and discounted becomes NPA as at the close of any year, interest accrued and credited to income account in the corresponding previous year, should be reversed or provided for if the same is not realised This will apply to Government guaranteed accounts also.

4.2.2 If interest income from assets in respect of a borrower becomes subject to non-accrual, fees, commission and similar income with respect to same borrower that have been accrued should ceased to accrue in the current period and should be reversed or provided for with respect to past periods, if uncollected.

4.2.3 Banks undertaking equipment leasing should follow prudential accounting standards. Lease rentals comprises two elements – a finance charge (i.e interest charge) and a charge towards recovery of the cost of the asset. The interest component alone should be taken to income account. Such income taken to income account, before the asset became NPA, and remained unrealised should be reversed or provided for in the current accounting period.     

4.3  Booking of Income on Investments in Shares & Bonds

4.3.1  As a prudent practice and in order to bring about uniform accounting practice among banks for booking of income on units of UTI and equity of All India Financial Institutions, such income should be booked on cash basis and not on accrual basis.

4.3.2 However, in respect of income from Government securities/bonds of public sector undertakings and All India Financial Institutions, where interest rates on the instruments are predetermined, income may be booked on accrual basis, provided interest is serviced regularly and is not in arrears.

4.4 Partial Recovery of NPAs

Interest realised on NPAs may be taken to income account provided the credits in the accounts towards interest are not out of fresh/additional credit facilities sanctioned to the borrower concerned.

4.5  Interest Application

4.5.1   In case of NPAs where interest has not been received for 90 days or more, as a prudential norm, there is no use in debiting the said account by interest accrued in subsequent quarters and taking this accrued interest amount as income of the bank as the said interest is not being received.  It is simultaneously desirable to show such accrued interest separately or park in a separate account so that interest receivable on such NPA account is computed and shown as such, though not accounted as income of the bank for the period.

4.5.2   The interest accrued in respect of performing assets may be taken to income account as the interest is reasonably expected to be received.  However, if interest is not actually received for any reason in these cases and the account is to be treated as an NPA at the close of the subsequent year as per the guidelines, then the amount of interest so taken to income in the corresponding previous year should be reversed or should be provided for in full.

4.5.3   With a view to ensuring uniformity in accounting the accrued interest in respect of both the performing and non-performing assets, the following guidelines may be adopted notwithstanding the existing provisions in the respective State Co-operative Societies Act:

(i) Interest accrued in respect of non-performing advances should not be debited to borrowal accounts 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' side of the balance sheet.

(ii)  In respect of borrowal accounts, which are treated as performing assets, accrued interest can alternatively be debited to the borrowal account and credited to Interest account and taken to income account.  In case the accrued interest in respect of the borrowal account is not actually realised and the account has become NPA as at the close of subsequent year, interest accrued and credited to income account in the corresponding previous year, should be reversed or provided for.

(iii)  The illustrative accounting entries to be passed in respect of accrued interest on both the performing and non-performing advances are indicated in the Annex 3.

4.5.4   In the above context, 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 can not be regarded as 'reserve' or a part of the owned funds of the banks.  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 banks to show 'Overdue Interest Reserve' as a distinct item on the 'Capital and Liabilities' side vide item 8 thereof.

5.  PROVISIONING NORMS

5.1 Norms for Provisioning on Loans & Advances

5.1.1   In conformity with the prudential norms, provisions should be made on the non-performing assets on the basis of classification of assets into prescribed categories as detailed in paragraph 3 above.

5.1.2   Taking into account the time lag between an account becoming doubtful of recovery, its recognition as such, the realisation of the security and the erosion over time in the value of security charged to the bank, the banks should make provision against loss assets, doubtful assets and sub-standard assets as below:

(i) Loss Assets

(a) The entire assets should be written off after obtaining necessary approval from the competent authority and as per the provisions of the Co-operative Societies Act/Rules.  If the assets are permitted to remain in the books for any reason, 100 per cent of the outstanding  should be provided for.

(b) In respect of an asset identified as a loss asset, full provision at 100 per cent should be made if the expected salvage value of the security is negligible.

(ii) Doubtful Assets

(a) Provision should be for 100 per cent of the extent to which the advance is not covered by the realisable value of the security to which the bank has a valid recourse should be made and the realisable value is estimated on a realistic basis.

(b) In regard to the secured portion, provision may be made on the following basis, at the rates ranging from 20 per cent to 100 per cent of the secured portion depending upon the period for which the asset has remained doubtful:

Tier I Bank 

Tier II Bank-

Few llustrations are  given at  Annex 5

(iii) Sub-standard Assets

A general provision of 10 per cent on total outstanding should be made without making any allowance for DICGC/ECGC guarantee cover and securities available.

(iv)  Provision on Standard Assets

(a) From the year ended March 31, 2000, the banks should make a general provision of a minimum of 0.25 per cent on standard assets.

(b) However, Tier II banks (as defined in circular dated May 6, 2009) will be subjected to higher provisioning norms on standard assets  as under:

The general provisioning requirement for all types of ‘standard advances’ shall be 0.40 per cent.  However, direct advances to agricultural and SME sectors which are standard assets, would attract a uniform provisioning requirement of 0.25 per cent of the funded outstanding on a portfolio basis, as hitherto.

(c) The provisions 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.

(d) If due to changes in the regulatory requirements on provisions to be maintained by banks, the provisions held by banks exceed what is required to be held by banks, such excess provisions should not be reversed.  In future, if by applying the revised provisioning norms, any provisions are required over and above the level of provisions currently held for the standard category assets ; these should be duly provided for.

(e) In case banks 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 segregated from Bad and Doubtful Debt Reserve and the same may be parked under the 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.

(f) The above contingent provision will be eligible for inclusion in Tier II capital.

(v) Higher provisions

There is no objection if the banks create bad and doubtful debts reserve beyond the specified limits on their own or if provided in the respective State Co-operative Societies Acts.

5.2 Provisioning for Retirement Benefits

Banks may have retirement benefit schemes for their staff, viz. Provident Fund, Gratuity and Pension.  It is necessary that such liabilities are estimated on actuarial basis
and full provision should be made every year for the purpose in their Profit and Loss Account.

5.3  Provisioning  Norms for sale of financial assets to Securitisation Companies (SC)/ Reconstruction Companies (RC)

(a) If the sale to SC/RC is at a price below the net book value(NBV) (i.e. book value less the provision held), the short fall should be written off / debited to P&L A/c of that year, subject to the provisions of the co-operative societies acts/rules/administrative guidelines in regard to write-off of debts.

(b) If the sale is for a value higher than the NBV, the excess provision will not be reserved but will be utilised to meet the shortfall/ loss on account of sale of other assets to SC/RC.  

5.4 Guidelines for Provisions in Specific Cases

(i)  State Government guaranteed advances

From the year ended March 31, 2006, State Government guaranteed advance and investment in State Government guaranteed securities would attract extant provisioning norms, if interest and/or principal or any other amount due to the bank remains overdue for more than 90 days irrespective of the fact whether the guarantee have been invoked or not.

(ii)  Advances granted under rehabilitation packages approved by BIFR/term lending institutions

(a) The existing credit facilities sanctioned to a unit under rehabilitation package approved by BIFR/term lending institutions, should continue to be classified as sub-standard or doubtful asset as the case may be.

(b) However, the additional facilities sanctioned as per package finalised by BIFR and/or term lending institutions, the income recognition and asset classification norms will become applicable after a  period of one year from the date of disbursement.

(c) In respect of additional credit facilities granted to SSI units which are identified as sick and where rehabilitation packages/nursing programmes have been drawn by the banks themselves or under consortium arrangements, no provision need be made for a period of one year.

(iii) Advances against fixed/term deposit, NSCs eligible for surrender, IVPs, KVPs, and life policies are exempted from provisioning requirements.

(iv)  Advances against gold ornaments, government securities and all other kinds of securities are not exempted from provisioning requirements.

(v)  Advances covered by ECGC/DICGC guarantee

(a)  In the case of advances guaranteed by DICGC/ECGC, provision should be made only for the balance in excess of the amount guaranteed by these Corporations.  Further, while arriving at the provision required to be made for Doubtful Assets, realisable value of the securities should first be deducted from the outstanding balance in respect of the amount guaranteed by these Corporations and then provision made as illustrated hereunder:

Example

Provision required to be made

(b) In case the banks are following more stringent method of provisioning in respect of advances covered  by the guarantees of DICGC/ ECGC, as compared to the method given above, they may have the option to continue to follow the same procedure.      

6. DIVERGENCE IN ASSET CLASSIFICATION AND PROVISIONING

(i) Banks should ensure scrupulous compliance with the instructions for recognition of credit impairment and view aberrations by dealing officials seriously.

(ii) Banks should establish appropriate internal systems to eliminate the tendency to delay or postpone the identification of NPAs, especially in respect of high value accounts. Banks should fix a minimum cut off point to decide what would constitute a high value account depending upon their respective levels. The cut off point should be valid for the entire year.

(iii) The responsibility and validation levels for ensuring proper asset classification may be fixed by the banks.

(iv)  Where there is wilful non-compliance by the officials responsible for classification and is well documented, RBI would initiate deterrent action including imposition of monetary penalties.

7.  Clarification on certain frequently asked questions is given at annex 6

Appendix

Master Circular on  Income Recognition, Asset Classification, Provisioning & Other Related Matters

A.  List of Circulars as of June 30, 2009 consolidated in the Master   Circular

B.  List of Other Circulars from which instructions have also been consolidated in the Master Circular