Income Tax Taxation

Income recognition norms for NPAs

Financial institutions categorize loans and advances in default or arrears as non-performing assets (NPAs). Debt is in arrears when the principal or interest payments are overdue or missed. The loan defaults when the loan terms are broken or the borrower cannot make payments—the time frame for classifying loans and advances as NPAs has been established by RBI. Let us discuss the income recognition norms for NPAs in detail.

Income Recognition Norms

The Reserve Bank of India has gradually implemented prudential norms for income recognition of the banks in accordance with international best practices and recommendations made by the committee on the Financial System. This is done to increase consistency and transparency in the published accounts.

Instead of calculating its income recognition strategy on any subjective factors, it should be objective and based on recovery history. The classification of bank assets must also be done using objective standards to guarantee that the rules are applied consistently and uniformly. Additionally, the type of assets based on the time they have been non-performing, the presence of security, and their realizable worth should be considered while provisioning.

Non-performing Assets

When an asset, including one leased, stops bringing in money for the bank or financial institution, it is considered non-performing.

• A loan or advance is considered a non-performing asset (NPA) if interest or a principal instalment is overdue for more than 90 days in the case of a term loan, the account is “out of order” in the case of an overdraft or cash credit (OD/CC), or both.
• For bills bought and discounted, the bill is still overdue after more than 90 days have passed.
• The instalment of principal or interest is overdue for two seasons of short-duration crops.
• For a single crop season, the principal or interest instalment is overdue for long-term crops.
• Regarding a securitization transaction carried out per the Reserve Bank of India (Securitization of Standard Assets) Directions, 2021, as amended from time to time, the amount of the liquidity facility has been outstanding for over 90 days.
• Regarding derivative transactions, the past-due receivables represent the positive mark-to-market value of a derivative contract if they are not paid after the set due date has passed by 90 days.

Classification of Assets

Based on the length of time an asset has been non-performing and the ability to collect on the debt, banks are required further to categorize non-performing assets into the following three groups:

• Substandard Assets
• Doubtful Assets
• Loss Assets

Substandard Assets – A substandard asset would have remained NPA for less than or equal to 12 months. Such an asset will have clearly identified credit vulnerabilities that jeopardize the debt’s ability and are characterized by the strong potential that the banks will suffer a loss if the flaws are not fixed.

Doubtful Assets – It would be considered suspicious if an asset stayed in the substandard category for a year. A loan that has been given an uncertain rating has all the flaws present in assets that were given a substandard rating, plus the additional quality that the flaws render complete collection or liquidation highly improbable and questionable based on the facts, conditions, and values that are now known.

Loss Assets – An asset is considered a loss asset if a loss has been discovered but not entirely written off by the bank, internal or external auditors, or an RBI examination. In other words, even though there may be some salvage or recovery value, such an asset is deemed uncollectible and of such little value that its continued status as a bankable asset is not warranted.

Income Recognition

Income Recognition is discussed under Regulation 3 of the Master Circular – Prudential Norms on Income Recognition, Asset Classification and Provisioning about Advances. As per Regulation 3, income recognition policy, reversal on income, leased assets, appropriation of recovery in NPAs, interest application and computation of NPA levels are discussed below:

Income Recognition Policy

• The income recognition policy needs to be unbiased and founded on recovery history. As a result, banks shouldn’t add interest to any NPAs or take it out of their earning accounts. This also applies to accounts that the government guarantees.
• However, if sufficient margin is present in the accounts, interest on advances against Term Deposits, National Savings Certificates (NSCs), Kisan Vikas Patras (KVPs), and life insurance policies may be moved to the income account on the due date.
• Banks should record any fees and commissions they receive from renegotiating or rescheduling outstanding debts on an accrual basis for the period covered by the credit extension in question.
• For loans where an interest repayment moratorium has been granted, revenue may be reported on an accrual basis for accounts that are still categorized as “standard.” This will be compared to the outline of “restructuring” in this Master Circular’s paragraph 16.
• Income recognition norms for loans towards ongoing projects involving DCCO deferment shall be subject to the instructions in the project under implementation. Those for loans against gold ornaments and jewellery for non-agricultural purposes shall be subject to the instructions as updated occasionally.

 Reversal of income

• The total interest that has accrued and been credited to the income account over the previous periods should be reversed if the same is not realized if any advance, including bills bought and discounted, becomes NPA. This also applies to accounts that the government guarantees.
• Capitalized interest, if any, corresponding to the interest accrued during such moratorium period need not be reversed if loans with a moratorium on interest payments (permitted at the time of loan sanction) become NPA after the moratorium term has passed.
• In the case of NPAs, accrued fees, commissions, and similar income shall stop in the current period and, if uncollected, be reversed about prior periods.

Leased Assets – The finance charge component of finance income [as defined in ‘AS 19 Leases’] on the leased asset that had accrued and was credited to the income account before the asset became non-performing and remaining unrealized should be reversed or provided for in the current accounting period.

Appropriation of Recovery in NPAs

As long as the credits in the accounts for interest do not derive from new or additional credit facilities sanctioned to the borrower in question, interest realized on NPAs may be included in the income account.

Banks should adopt an accounting principle and exercise the right of appropriation of recoveries in a uniform and consistent manner without an explicit agreement between the bank and the borrower regarding the purpose of grant of rallies in NPAs (i.e. towards principal or interest due).

Interest Application

When an account becomes non-payable, banks should stop applying interest and reverse any previously charged claim but not collected by debiting the profit and loss account. However, the accrued interest may still be recorded in a Memorandum account in the statements of the banks. Interest recorded in the Memorandum account should not be considered when calculating Gross Advances.

Computation of NPA levels

It is advised that banks use the formula in Annex-1 to calculate their Gross Advances, Net Advances, Gross NPAs, and Net NPAs under the Master Circular – Prudential norms on Income Recognition, Asset Classification and Provisioning about Advances.

Factors Lead to Non-Performing Assets (NPAs) 

The following are the causes of non-performing assets:

• It is significantly riskier for banks to lend money to people whose creditworthiness isn’t assured.
• Banks cannot reduce their losses by completely comprehending the bank’s sufficiency in terms of a loan or capital loss over time.
• The company’s promoters are diverting money to other projects.
• Banks attempt to finance ineffective ventures.
• Commercial banks don’t have enough channels for gathering and sharing credit data.
• Unskilled loan recovery from unexpected debtors.

Conclusion

Banks are recommended to ensure that reasonable repayment plans can be established based on cash flows with borrowers when making loans and advances. This would greatly aid the borrowers’ quick repayment, enhancing the history of advance recovery. The lender and the borrower must be aware of the performing and non-performing assets. If the purchase is non-performing and does not pay the interest, it may negatively affect the borrowers and financial institutions.

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