Adoption of IRAC Norms in small NBFCs 

Vaibhav Rathi

30 Mar, 2024

The RBI has tightened the rules for NBFC asset categorization, which might lead to more loans from non-banking financial institutions being classified as NPAs and increase the need for provisioning.

Clarifying its prudential norms on income recognition, asset classification, and provisions relating to advances, the central bank released the guidelines. Certain facets of the regulatory requirements are being addressed in order to ensure consistency in the application of IRACP norms across all lending institutions. And that applies to all institutions involved in the business of lending. Let us discuss the adoption of IRAM norms in small NBFCs.

Background

All entities in the financial services industry must provision assets in accordance with RBI standards. Current standards for asset classification and provisioning for NBFCs are provided by the SI-NBFC Master Directions, NSI-NBFC Master Directions, and HFC Master Directions. According to the Master Directions, each NBFC must categorise its lease/hire purchase assets, loans and advances, and any other forms of credit into the following classes: 

• (i) Sub-standard assets;
• (ii) Doubtful assets; and 
• (iii) Loss assets. 

This is done by taking into account the degree of well-defined credit weaknesses and the extent of dependence on collateral security for realisation. Each of these assets must be provisioned at the rates the RBI specifies. Additionally, NBFCs must declare in their financial statements any provisions made in accordance with RBI requirements.

Income Recognition Policy

The Prudential Norms state that rather than being based on subjective factors, income recognition procedures should be based on objective standards that guarantee revenue is recognised in accordance with the record of recovery. For the purpose of income recognition, banks are not permitted to charge or debit interest on any non-performing asset (NPA) account, including assets that are backed by the government.

However, as long as sufficient margin is provided, interest on loans against term deposits, National Savings Certificates (NSC)¹, Indira Vikas Patra (IVP), Kisan Vikas Patra (KVP), and life insurance policies may be recognised on the due date without realisation.

Renegotiations or rescheduling of outstanding loans may result in fees and commissions for the banks, which should be acknowledged on an accrual basis over the period covered by the renegotiated or rescheduled extension of credit. 

The interest on Government-guaranteed Advances should not be put into an Income Account until the interest has been Realised if the Advances Become NPA.

Categories for Asset Classification

According to the Prudential Norms, banks must divide non-performing assets into three groups: substandard, doubtful, and loss assets.

• Substandard Assets – An asset would be considered substandard if it has remained NPA for less than or equivalent to 12 months. Such an asset will have clearly identified credit problems that put the liquidation of the debt in jeopardy and are typified by the strong likelihood that the banks will suffer some loss if deficiencies are not fixed.
• Doubtful Assets – Assets that are in doubt are those that have stayed in the substandard category for a continuous 12 months. A loan that has been given the “doubtful” classification has all the same flaws as assets that were given the “sub-standard” designation, but with the additional feature that the flaws render full collection or liquidation highly dubious and problematic.
• Loss Assets – Assets that are identified by internal or external auditors or by an RBI inspection that have incurred losses that have not yet been fully written off by the bank are referred to as loss assets. 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. The classification is based on how long the asset has been non-performing and/or how long the debt has gone unpaid. To ensure uniform and consistent application of the Prudential Norms, banks are required to conduct the classification process using objective criteria.

Management and statutory auditors’ responsibilities

The management of the small NBFC and the statutory auditors are both accountable for making sure that the necessary provisioning has been made in accordance with the Prudential Norms. The age of assets categorised as NPA and the realisable value of the available security under different accounts should be used as the basis for provisioning.

NBFCs may maintain greater consistency and transparency in their financial reporting by complying with the amended Master Circular on Prudential Norms, which will ultimately help to create a more stable and strong financial lending sector in India.

Banks must identify signs of impending stress in borrower accounts and classify them as Special Mention Accounts (SMA), and if necessary, classify them as Non-Performing Assets (NPA) in accordance with RBI guidelines on Prudential norms on Income Recognition, Asset Classification, and Provisioning pertaining to Advances. 

Customers are urged to follow these steps and make timely main and interest payments (on or before the due date) to prevent their accounts from being labelled as SMA or NPA.

Adoption of IRAC norms for small NBFCs

Classification of Non-Performing Assets (NPA) Currently, the NBFCs-ND with an asset size of less than 500 crores (i.e., non-systemically important, non-deposit-taking NBFCs) designate assets with an overdue period of more than 180 days as NPA (NPA norm). The NPA norm for all other NBFCs is 90 days. The NPA standards have now been standardised by the RBI to 90 days for all NBFCs. The NBFCs in the base layer, including the NBFCND (i.e., the non-systemically important, non-deposit-taking NBFCs), will be impacted by this modification. As a result, NBFCs at the base layer have been granted the following glide path in order to follow the 90-day NPA norm: 

Impact on the Indian Economy

These rules represent a step towards regulating the Indian financial sector, and more specifically, the Fintech sector. The NBFCs/cooperatives and commercial banks’ regulatory deficiencies will be filled by the new regulatory framework. It is essential to introduce uniformity to their regulation, which the RBI accomplished through its regulatory framework.

In addition, according to the most recent provisioning standards, it is anticipated that higher provisioning would result in a minor drop in liquidity in the short term because more money would wind up being set aside and not used for lending. Interest rates might rise as a result of this. But over time, this action will significantly contribute to reducing systemic risks and enhancing regulatory control, further bolstering the NBFC ecosystem.

Conclusion

There are now many different types of NBFCs in India, and it is essential to introduce uniformity to their regulation, which the RBI was able to accomplish through its regulatory framework. Small NBFCs should be aware that this action will probably lead to an increase in the NBFCs’ compliance standards.

FAQs: –

1. https://nsiindia.gov.in/InternalPage.aspx?Id_Pk=90