RBI

Non-Performing Assets and its Provisioning for the Banks

The Reserve Bank of India defines a bank as a legal entity that acts as a financial institution and performs deposit and lending functions. The function of lending includes procuring loans as per the demand of the customer, and any loan procured by the bank to its customer is an asset of the bank on which the bank earns profits using interest. It is a type of service provided by the bank to its customers. This loan that the bank provides is given to the customers from the deposits of account holders in that particular bank.

Before 1991, the banks in India had no provision related to income recognition, classification of assets, and provisioning of assets. In 1991 the committee on the financial system, popularly known as Narsimham Committee It, was the first one to introduce these terminologies between the years 2010-11 Reserve Bank of India in its master circular UBD.PCB.MC.No.3/09.14.000/2010-11 dated July 2010 issued guidelines about income recognition, asset classification, provisioning, and other related matters, in this circular the Reserve Bank of India talks about non-performing assets, their classification, and provisioning.

Understanding the Concept of Non-Performing Assets

The guidelines of the Narsimham committee became operational by 1996 when, on March 31st, 1996, three categories of assets were introduced: standard, sub-standard, and doubtful. In 2005, the Master circular issued by the Reserve Bank of India defined non-performing assets as a loan or advance of the interest or instalment of the principal amount that remains overdue for 90 days as of the date of the balance sheet, in simple words, Non-performing assets are those assets that do not generate income i.e. the loan that the bank lends to its customer is an asset to it,. It is a duty upon the customer to repay that loan within the timeline specified in the terms and conditions,. Still, at times banks come across the situation where the borrowers postpone or refuse to pay back the loan they procured from the bank.

Now, this asset, in the form of a loanbecomes a non-performing asset , when it isn’t repaid by the borrower, including the principal amount and the intereet.

As per the above-mentioned notification of the Reserve Bank of India, the bank gives 90 days to a borrower to repay the loan. If the borrower doesn’t repay in the said time frame, the assets, i.e. loan assets, are declared non-performing.

For example-

Person “A” borrowed a home loan of INR 2 lakhs from a bank.

The terms and conditions of the contract specifically stated that ‘A’ needs to repay the loan within 2 years along with the interests. Still, upon completion of 2 years, the borrower neither pays back the principal amount nor the interest of these 2 years.

Now, the bank will give a 90-day notice to pay the entire amount along with the interest.

If A fails to pay back the entire amount, this loan, which is an asset, becomes a non-performing asset for the bank.

Implications of NPA on Economy and Banking Along with Factors Responsible

The stability of a financial institution like a bank is important for any nation; if there is a high number of non-performing assets, the smooth flow of credit will be affected in a territory because the cycle of lending-repaying-borrowing will be broken. The priority of the banks will be repaying their depositors from whom they borrowed the money, and to make this repayment, they will further borrow additional funds because the bank itself is now in debt, it will refuse to fund any new project, resulting in slowing down any new project and ultimately the economy.

The higher the percentage of non-performing assets, the higher the bank will concentrate on its recovery, resulting in no time for business expansion. Ultimately, capital asset erosion will occur, and it will be difficult for the bank to sustain,, leading to its failure.

Following are the factors responsible for a non-performing asset-

• Modernization, diversion of funds, and setting up new projects.
• Overrunning the cost while implementing the projects.
• Factors like price escalation of raw materials, natural calamities, and recession.
• Product failure due to failure in market capitalization, inefficient management, and poor labour laws resulting in continuous strikes, strained labour relations, technical problems, etc.
• Sudden change in government policies like excise, import duties, etc.
• Involvement of senior officials in white-collar crimes like fraud, misappropriation, etc.

Government Initiatives for Curbing the Non-Performing Asset-

• Debt recovery tribunal- appointing bank nodal officers for recovery purposes at head offices and zonal offices.
• Setting up assets reconstruction companies(ARC) who will work as resolution agents of the banks
• Activity-wise analysis of non-performing assets is to be conducted, and only the new loans will be sanctioned.
• A credit monitoring mechanism should be maintained in a bank where a unit must ensure the early detection of signs of distress.
• Strengthening the recovery laws so that non-performing assets and the loss arising out of it could be avoided.

Classification of Non-Performing Assets-

According to the Reserve Bank of India, an asset is classified into 4 broad categories: standard asset, sub-standard asset, doubtful asset, and loss asset. Amongst these, the standard asset is performing, and the other three are non-performing assets. This classification of these assets is as follows-

Standard asset-

A standard asset is a performing asset that generates a continuous income, and their repayments are made whenever they fall due. These carry normal risk and are not within the category of a non-performing asset. According to the Reserve Bank of India, no special provision is required for standard assets.

Sub-standard asset-

A substandard asset remains non-performing for a period less than or equal to 18 months, effective from 31^st March 2001. In the case of these assets, the market value of the securities charged is not enough, i.e., the borrower’s or the guarantor’s net worth is not enough and will not be sufficient to recover the bank’s dues.

Doubtful assets-

An asset that is non-performing for a period exceeding 18 months with effect from 31^st March 2001.

Loss Asset-

These are the assets that have been non-performing for more than 36 months. In the case of financial audit or inspection by the Reserve Bank of India, these assets are identified as not being written off wholly and, hence, are considered uncollectible.

Types of Non-Performing Assets and Differences between them-

When a commercial bank offers loans and the recovery of that loan, which is an asset to the bank, has exceeded 90 days, it will be considered a gross non-performing asset.

Whereas the provisioning amount that commercial banks offer to cover their debts is deducted for the unpaid loans, this overall sum will be a net non-performing asset.

Key differences between gross and net non-performing assets based on –

• Meaning –

The gross non-performing asset is the total amount of debts the organization failed to collect from the people who had a contractual obligation to repay those debts. Net non-performing assets are the amount deducted as a provision for an unpaid or doubtful debt from the total sum of the loans.

• Calculation of GNPA and NNPA

Gross non-performing assets are the total sum of loans defaulted by individuals from any financial institution, whereas when the provision amount is deducted from the gross non-performing asset, what remains is a net non-performing asset.

• Default period-

A financial institute needs to recover the assets on debt within a stipulated time, but even after that, a fixed grace period is given to the individuals within which they need to begin the payment of their loans with interest. Still, on expiry of such payment duration the financial institution will have to present in written the debts which aren’t paid this grace period can only be availed for the calculation of a gross non-performing asset, in case of a net non-performing asset the calculation of the unpaid debts are done instantly without any provision of the grace period.

• Effects

The gross non-performing assets have a high impact on the equity value of the company, leading to the company’s low share value, whereas the net non-performing assets greatly affect the liquidity and profitability of the financial institution; in simple words, if there are low cash flow, the institution will be unable to perform any task.

Provision of Non-Performing Assets for NBFCs-

NBFCs, as defined by the Reserve Bank of India, are non-banking financial companies registered under the Companies Act, 1956. these are engaged in the business of loans and advances, acquisition and issuance of shares, equity, bonds, debentures, etc., and any non-banking organization, the principal business of which is receiving deposits using lump sum amounts or in instalments will be a residuary non-banking company and will be part of an NBFC.

The circular of Reserve Bank of India RBI/2021-22/112 DOR.CRE.REC.No.60/03.10.001/2021-22 dated October 22, 2021, was issued to formulate scale-based regulation(SBR), this circular was a revised regulatory framework for NBFCs, in this circular was mentioned in detail the provisions related to the non-performing assets and their provisioning.

With this circular, the Reserve Bank of India harmonized the non-performing assets rule for NBFCs, and the overdue period for all is fixed at 90 days.

Points to Ponder Before Calculating Non-Performing Assets

1. The temporary nature of deficiency and non-availability of stock statements or outstanding balance, i.e. within 90 days, involves no liability.
2. An account will be considered holding non-performing assets where the regular or ad hoc credit limits have not been reviewed or renewed within 90 days from the due date or the date of ad hoc sanction.
3. Over dues are repaid and accounts are regularized before the balance sheet through genuine sources, then, it will not be considered as a non-performing asset.
4. In any of the facilities of the borrower, a non-performing asset, be it cash credit or a term loan, in that case, both these facilities will be considered as non-performing assets, and even their type, i.e. substandard or doubtful, will be similar.
5. In cases of credits that the central government backs, the overdue will be considered a non-performing asset the moment it repudiates its guarantee.
6. Bank fixed deposits, Life insurance policies, UTIs, and NSC are self-liquidating and, will not be treated as non-performing assets.

Provisioning of Non-Performing Assets-

Any country’s entire population depends on banks or financial institutions for depositing their money. But no financial institution makes any profit merely based on deposit accounts; therefore, to maximize profits, there are variable services that a bank provides to its customers. One such service is lending loans, on which attached is the rate of interest. When not repaid by the borrower within the time limit as directed by the Reserve Bank of India, these loans become a non-performing asset.

To keep the economy running and the trust of the people intact in a financial institution, the Reserve Bank of India introduced the concept of provisioning, where it asked the banks to keep aside a certain amount of their profits in a particular quarter, which could be used to maintain a healthy balance sheet and can cover up the loss due to the non-performance of assets. This is important for both a banking organization and an NBFC because the assets of today can turn into a future loss.

    Norms for Provisioning

• Based on the classification of assets

S.no.	category	Period	NPA	Provisioning
1.	standard	Nil	Non NPA	0.25% 1% 2% 0.40% On gross amount
2.	Sub-standard	Nil	NPA up to 12 months	Secured exposure	15%
				Unsecured exposure	25%
				Unsecured exposure: infrastructure loan	20%
3.	Doubtful	Upto 1 year	NPA up to 24 months	Unsecured – 100%
				Realizable value of assets- 25%
		Up to 3 years	NPA up to 48 months	Unsecured- 100%
				Realizable value of assets-40%
		Over 3 years	NPA above 48 months	100%
4.	Loss	Nil	Nil	100%

• Based on standard advances

S.no.	Sector	provisioning
	Advances in agriculture and SME	0.25%
	Commercial real estate	1%
	Housing loan at teaser rates	2%
	Housing loan 1 year from the date of reset higher rates	0.40%
	Restructuring accounts	2%
	Gross account for advances other than the above-listed	0.40%

•  C. Other relevant norms

1. Country-based risk provision should lie between 0.25% to 100%
2. Voluntary provisions for advances at rates higher than the prescribed regulations could be made by the banks upon the approval of the board of directors.
3. Suppose the non-performing asset balance value exceeds Rs. 5 crores and above. In that case, the financial institution needs to formulate a policy for annual stock audit by an external agency in respect of immovable properties valuation to be carried out once every 3 years by approved value.
4. PCR, i.e. provisioning coverage ratio, indicates the extent of funds a bank has kept aside to cover losses occurring from loss of assets.

Conclusion-

The general myth that a non-performing asset and its provisioning is of importance to the banking sector was debunked by the Reserve Bank of India by including non-banking financial companies (NBFCs) in its ambit. The reserve bank aimed to include all the financial institutions within the ambit of its master circular and to protect all such institutions, the business of which is maintaining deposits and lending loans. Any financial institution is stability depends on its assets; when advanced to a borrower,, these assets are expected to return profits, and in the worst-case scenario, the institution expects the return of its standard invested asset. At times, an asset becomes non-performing, i.e. neither it regains the standard asset nor any profit arising out of interests, due to which the Reserve Bank of India, through its guidelines, suggests every financial institution make a system of provisioning of assets, i.e. keeping aside some amount from their profit of the quarter so that in case of non-performance of assets the stability and basic functioning of the financial institution is intact.

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