HISTORY-

Prior to 1992 Banks used to recognize Interest on Entire Portion of Loans and Advances,
irrespective of the fact that whether each of the Loan advanced is good or bad.

This has resulted into following Draw Backs;

 The Banks used to recognize Interest on Bad Loans.

 Due to recognition of Interest on Income on entire loans and advances it was difficult for
the reader of Balance Sheet the actual financial health of the Bank.

 Bank used to pay Income Tax even on the portion of the Interest pertaining to Bad Loans.

 It was difficult to fix the accountability on Bank Staff in respect of Bad Loans advanced.

The R B I. introduced the NPA norms relying on the Narsimham Committee recommendations &
prudential norms for Income Recognition, Asset Classification and provisioning for the advance
portfolio of the banks with the intention for proper disclosure of profit & loss and reflect the
financial health of bank.

Narsimham Committee recommendations on prudential norms –

. The balance sheets of banks and financial institutions should be made transparent. Full
disclosures showed be made in the balance sheets as recommended by the International
Accounting Standards Committee.

. Bank’s assets should be classified into:

(i) standard,
(ii) substandard,
(iii) doubtful and
(iv) loss assets.

. A suitable mechanism should be devised with legislative measures so devised for the quick
recoveries of loans and enforcement of security charged. Special Tribunals should be created. An
Assets Reconstruction Fund (ARF) is created which could take over from the banks and financial
institutions a portion of the bad and doubtful debts at a discount.

. Non-performing assets
i) The 1998 report blamed poor credit decisions, behest-lending and cyclical economic factors
among other reasons (in addition to ‘priority sector lending’) for the build-up of the non-
performing assets of the banks to uncomfortably high levels.

ii) The Committee recommended creation of Asset Reconstruction Funds or Asset Reconstruction
Companies to take over the bad debts of banks, allowing them to start on a clean-slate. The option
of recapitalization through budgetary provisions was ruled out. Overall, the committee wanted a
proper system to identify and classify NPAs, with NPAs to be brought down to 3% by 2002 and for
an independent loan review mechanism for improved management of loan portfolios. The
committee's recommendations led to introduction of a new legislation which was subsequently
implemented as the Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act (SARFAESI), 2002.

Consequent to report from M.Narasimhan committee Reserve Bank started issuing guidelines on
the concept of Income Recognition, Asset Classification and Provisioning pertaining to Advances.
These provisions amended from time to time are being popularly called as IRAC norms.

. PRUDENTIAL ACCOUNTING NORMS-

1. INCOME RECOGNITION
2. ASSET CLASSIFICATION
3. PROVISIONING

PRUDENTIAL NORMS

The policy of income recognition should be objective and based on the record of recovery
rather than on any subjective considerations.

Likewise, the classification of assets of banks has to be done based on objective criteria which
would ensure a uniform and consistent application of the norms.

Also, the provisioning should be made based on the classification of assets based on the period
for which the asset has remained non-performing and the availability of security and the
realisable value thereof.

Banks are urged to ensure that while granting loans and advances, realistic repayment
schedules may be fixed based on cash flows with borrowers. This would go a long way to
facilitate prompt repayment by the borrowers and thus improve the record of recovery in
advances.

Automation of IRAC Norms and Provisioning processes in banks

 Banks were advised to have appropriate IT systems in place for the identification of Non-
Performing Assets (NPA) and the generation of related data/returns, both for regulatory
reporting and the bank’s own MIS requirements.

It was observed that the processes for NPA identification, income recognition, provisioning,
and generation of related returns in many banks are not yet fully automated.

Now RBI issued circular Ref. No. DoS.CO.PPG./SEC.03/11.01.005/2020-21 Dated September

14, 2020 on Automation of Income Recognition, Asset Classification, and Provisioning
processes in banks.

To ensure the completeness and integrity of the automated Asset Classification (classification
of advances/investments as NPA/NPI and their up-gradation), Provisioning calculation, and
Income Recognition processes, banks are advised to put in place / upgrade their systems to
conform to the following guidelines latest by June 30, 2021.

As per the norms coverage of accounts are as under.

 All borrowed accounts, including temporary overdrafts, irrespective of size, sector, or types
of limits, shall be covered in the automated IT-based system (System) for asset
classification, upgradation, and provisioning processes. Banks’ investments shall also be
covered under the System.

 Asset classification rules shall be configured in the System, in compliance with the
regulatory stipulations.

 Calculation of provisioning requirements shall also be System-based as per pre-set rules for
various categories of assets, value of security as captured in the System, and any other
regulatory stipulations issued from time to time on provisioning requirements.

 In addition, income recognition/derecognition in case of impaired assets (NPAs/NPIs) shall

be system-driven, and the amount required to be reversed from the income account
should be obtained from the System without any manual intervention.

 The System shall handle both the downgrade and upgrade of accounts through Straight
Through Process (STP) without manual intervention.

 Frequency: The System-based asset classification shall be an ongoing exercise for both
down-gradation and up-gradation of accounts. Banks should ensure that the asset
classification status is updated as part of the end process.

Basic Concepts-IRAC Norms

While Implanting these Guidelines the Banks have to follow the following Steps

1. Classification of Advances based on Performance of the Advances into Performing and Non-
Performing

2. Recognize Interest on Performing Advances

3. Reverse the Interest on Non-Performing Advances if Interest is already accounted 

4.Start accounting the Interest on these Non-performing Advances only on actual receipt of money.

5.Make suitable Provisions on Performing and Non Performing Advances as per “RBI Guidelines”.

INCOME RECOGINITION NORMS

 IRAC are rules that prescribe when a loan should be declared as a non-performing asset
(NPA).

 Once a loan is an NPA, the RBI requires that any recovery should not be classified as income.

 Banks are also required to share information regarding large borrowers with the RBI for its
Central Repository of Information on Large Credits (CRILC).

1. Banks should not charge and take to income accounts interest accrued on non-performing
assets. Income from non performing assets is not recognized on accrual basis but is booked
as income only when it is actually received.

2. Interest on advance against Term deposits, NSC, Indira & Kisan Vikas Patra & LIC may be
taken to income subject to availability of Margin.

3. In the absence of clear agreement between the Bank and the Borrower, an appropriate
policy to be followed in uniform and consistent manner.

4. On an account turning NPA, banks should reverse the interest already charged and not
collected by debiting Profit and Loss account, and stop further application of interest.
However, banks may continue to record such accrued interest in a Memorandum account
in their books. For the purpose of computing Gross Advances, interest recorded in the
Memorandum account should not be taken into account.

ASSET CLASSIFICATION NORMS

FOR A BANK THE FIRST AND THE FOREMOST THING IS TO CLASSIFY THE NON-PERFORMING
ASSETS, SO THAT THEY CAN CLASSIFY THEIR ASSESTS INTO VARIOUS HEADS.

NON-PERFORMING ASSETS

An asset, including a leased asset, becomes non-performing when it ceases to generate income for
the bank. A non-performing asset (NPA) is a loan or an advance where;
 1. Loan Account: For loan account, if the Interest and/or instalment of principal remain
‘overdue’ for more than 90 Days.

Overdue status: Any amount due to the bank under any credit facility is ‘overdue’ if it is not paid
on the due date fixed by the bank.

2. Cash Credit or Overdraft Account: The account remains ‘out of order’ for more than 90
days.

Out of order status: Either the outstanding balance remains continuously more than the
sanctioned limit/drawing power or there are no credits continuously for 90 days as on the date of
Balance Sheet or credits are not enough to cover the interest debited during the same period.

3. The Limit is not reviewed within 180 days from the due date of renewal.

4. Where stock statement has not been received for 90 days or more in case of Cash Credit
Accounts.

5. Bills- The bill remains overdue for a period of more than 90 days from the due date of
payment.

6. For Direct Agricultural loans: For short duration crops the Interest or instalment remaining
overdue for 2 crop seasons & for long duration crop the Interest or instalment remaining
overdue for 1 crop season.

7. The credit facilities backed by the Guarantee of Central Govt. though overdue, may be
treated as NPA only when the Govt. repudiates its guarantee when revoked.

8. The credit facilities backed by the Guarantee of State Govt. become NPA normally.

9. In the case of bank finance given for industrial projects, housing loan or for agricultural
plantations etc. where moratorium is available for payment of interest, payment of
interest becomes ‘due’ only after the moratorium or gestation period is over.
Advances under consortium arrangements: Asset classification of accounts under consortium should
be based on the record of recovery of the individual member banks and other aspects having a
bearing on the recoverability of the advances.

Projects under implementation: For all projects financed by the FIs/ banks , the ‘Date of Completion’
and the ‘Date of Commencement of Commercial Operations’ (DCCO), of the project should be clearly
spelt out at the time of financial closure of the project and the same should be formally
documented. These should also be documented in the appraisal note by the bank during sanction of
the loan.

There are occasions when the completion of projects is delayed for legal and other extraneous
reasons like delays in Government approvals etc. All these factors, which are beyond the control of
the promoters, may lead to delay in project implementation and involve restructuring /
reschedulement of loans by banks.

Accordingly, the following asset classification norms would apply to the project loans before
commencement of commercial operations.

For this purpose, all project loans have been divided into the following two categories:

1. Project Loans for infrastructure sector

2. Project Loans for non-infrastructure sector

For the purpose of these guidelines, ‘Project Loan’ would mean any term loan which has been
extended for the purpose of setting up of an economic venture. Further, Infrastructure Sector is a
sector as defined in extant Harmonised Master List of Infrastructure of RBI.

Classification of the loan against Term Deposits, NSCs, KVPs/IVPs, etc.: Advances against term
deposits, NSCs eligible for surrender, IVPs, KVPs and life policies need not be treated as NPAs,
provided adequate margin is available in the accounts. Advances against gold ornaments,
government securities and all other securities are not covered by this exemption.

Classification will be done borrower-wise & not facility-wise: when only one facility to a
borrower/one investment in any of the securities issued by the borrower becomes a problem
credit/investment and not others. Therefore, all the facilities granted by a bank to a borrower and
investment in all the securities issued by the borrower will have to be treated as NPA/NPI and not the
particular facility/investment or part thereof which has become irregular.

In case of loans to PACS/FSS classification will be done facility-wise: In respect of advances granted
by banks to PACS/ FSS under the on-lending system, only that particular credit facility granted to
PACS/ FSS which is in default will be classified as NPA and not all the credit facilities sanctioned to a
PACS/ FSS.

(PACS stands for Primary Agricultural Credit Society, and FSS stands for Farmers Service Society)

Reversal of Income: If any advance, including bills purchased and discounted, becomes NPA, the
entire interest accrued and credited to income account in the past periods, should be reversed if the
same is not realised. This will apply to Government Guaranteed advances also.

In respect of NPAs, fees, commissions, and similar income that have accrued should cease to
accrue in the current period and should be reversed with respect to past periods, if uncollected.
Leased Assets: The finance charge component of finance income [as defined in ‘AS 19 Leases’ issued
by the Council of the Institute of Chartered Accountants of India (ICAI)] on the leased asset which has
accrued and was credited to the income account before the asset became nonperforming, and
remaining Unrealised, should be reversed or provided for in the current accounting period.

Upgradation of Loan Accounts classified as NPAs: If arrears of interest and principal are paid by the
borrower in the case of loan accounts classified as NPAs, the account should no longer be treated as
non-performing and may be classified as ‘standard’ accounts.

Appropriation of recovery in 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.

In the absence of a clear agreement between the bank and the borrower for the purpose of
appropriation of recoveries in NPAs (i.e. towards principal or interest due), banks should adopt an
accounting principle and exercise the right of appropriation of recoveries in a uniform and
consistent manner.

Interest Application: On an account turning NPA, banks should reverse the interest already charged
and not collected by debiting Profit and Loss account, and stop further application of interest.
However, banks may continue to record such accrued interest in a Memorandum account in their
books. For the purpose of computing Gross Advances, interest recorded in the Memorandum
account should not be taken into account.

COMPUTATION OF NPA LEVELS

Banks are advised to compute their Gross Advances, Net Advances, Gross NPAs and Net NPAs, as
per the format given below.

 Gross Advances = Standard Asset Plus Gross NPA

 Gross NPAs as a percentage of Gross Advances = Gross NPA/Gross Advances

 Net Advances = Gross Advances – Deductions

 Deductions includes:

 Net NPAs = Gross NPAs minus Deductions (listed above)

 Net NPAs as percentage of Net Advances = Net NPAs/ Net Advances (in %)

Upgradation of loan accounts classified as NPAs: If arrears of interest and principal are paid by the
borrower in the case of loan accounts classified as NPAs, the account should no longer be treated as
nonperforming and may be classified as ‘standard’ accounts.

Early Recognition of Stress: Before a loan account turns into a NPA, banks are required to identify
incipient stress in the account by creating three sub-categories under the Special Mention Account
(SMA) category as given in the table below:

ASSET CLASSIFICATION
Banks are required to classify non-performing assets further into the following three categories
based on the period for which the asset has remained nonperforming and the realisability of the
dues:

1. Substandard Assets

2. Doubtful Assets

3. Loss Assets

Sub-Standard Assets – Account which has remained in NPA category for not more than 12 months.
As to realisability these accounts show credit weakness and there is a distinct possibility that the
Bank will sustain some loss if the deficiencies are not corrected.

Doubtful Assets – Account that remained in the NPA category for more than 12 months. A loan
classified as Doubtful has all the weaknesses inherent to Sub-Standard assets with the added
characteristic that the full recovery of the advance is highly improbable due to erosion of security
value or fraud or such other reasons.

Loss Assets – Account where Loss has been identified by the bank or Internal Auditors or External
Auditors or by RBI Inspector but the amount has not been written off. It is an asset that is
considered uncollectible although there may be some salvage or recovery value.

DETERMINATION OF ASSET CLASSIFICATION AND HEALTH CODE

To Determine the correct Asset Classification of an NPA borrower two aspects are Important:

1. “NPA Since” Date and,

2. “Value of Security”

Note– When RVS (Both Primary & Collateral) falls below 10% of the O/S balance of the
account, the account is straightway classified as ‘LOSS’ and when RVS is above 10% but less
than 50% of the O/S balance, it is straightway classified as ‘DOUBTFUL’.

RVS: Value of Security (Realisable Value of Security) to reckon NPA is the total of the amounts
of security available in each account of the borrower:

1. Value of Principal (Primary) Security,

 2. Value of security, other than Primary Security,

3. Value of Credit/Cash Margin,

4. Value of Guarantee (only of the Nature of Guarantee Cover obtaining in the account i.e.,
(ECGC), (DICGC) (CGFMU) and (CGTMSE).

NET OUTSTANDING (NOS) = Total Outstanding less amount of Unrealised Interest (URI).

Determination of Asset Classification and Assets Code from Standard to NPA as under;
SUB-STANDARD ASSET CLASSIFICATION

A) Where NPA since the date is up to 12 months from the Current Date:

1. Asset Code will be determined as Sub- Standard (Secured), except for as at ‘b’ below.
ASSET CODE- 21

2. Asset Code will be determined as Sub-Standard (Unsecured), if the unsecured

portion/RVS as stipulated & ascertained is not more than10% abinitio (Clean
Personal loan, Clean OD etc.). eg- education loan personal loan ASSET CODE- 22

3. Asset Code will be determined as Doubtful I, if erosion of RVS is more than 50% of
the value accepted in the last inspection. ASSET CODE- 31

4. Asset Code will be determined as Loss if erosion of RVS is more than 90% of the
value accepted in the last inspection. ASSET CODE-40

DOUBTFUL ASSETS-

B) Where NPA since date is more than 12 months and up to 24 months from the current date:

1. Asset code will be determined as Doubtful I if the RVS is not less than 10% of the
NOS.(NET OUTSATNADING) ASSET CODE- 31

2. Asset code will be determined as Loss, if the RVS is less than 10% of the NOS.
ASSET CODE- 40

C) Where NPA since date is more than 24 months and up to 48 months from the current date:

1. Asset code will be determined as Doubtful II, if the RVS is not less than 10% of the
NOS. ASSET CODE-32
 2. Asset code will be determined as Loss, if the RVS is less than 10% of the NOS. ASSET
CODE-40

D) Where NPA since date is more than 48 months from the current date:

1.Asset code will be determined as Doubtful III. ASSET CODE-33

2.Asset code will be determined as Loss, if the RVS is less than 10% of the NOS. ASSET CODE- 40

CATEGORIES, CODE AND PERIODS OF NPA ASSETS

Category Period in category

Sub-Standard (Secured) Up to 1 year from NPA date

Sub-Standard (Unsecured) Up to 1 year from NPA date

Doubtful I (D1) Above 1 year to 2 years from NPA date

Doubtful II (D2) Above 2 years to 4 years from the NPA date

Doubtful III (D3) More than 4 years from NPA date

Loss No time limit

PROVISIONING NORMS

The primary responsibility for making adequate provisions for any

diminution in the value of loan assets, investments or other assets is that
of the bank management and the statutory auditors.

Loss assets: Loss assets should be written off. If loss assets are
permitted to remain in the books for any reason, 100 percent of the
outstanding should be provided for.

Doubtful assets: Provision for doubtful assets should be done as under;

1.100 percent 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
and the realisable value is estimated on a realistic basis.
2.In regard to the secured portion, provision may be made on the
following basis, at the rates ranging from 25 percent to 100 percent of
the secured portion depending upon the period for which the asset has
remained doubtful.

SUMMARY OF
PROVISION IN NPA
ACCOUNTS

NPA Category Provision

Amount

(RBI
Guideline)
Sub- Standard15% of Net
(Secured) Outstanding
Sub- Standard25% of Net
(Unsecured) Outstanding
Unsecured
Exposures in
respect of
Infrastructure
loan accounts
20% of Net
where certain
Outstanding
safeguards
such as
Escrow
accounts are
available
Doubtful I
25% of Net
(Fully securedOutstanding
by RVS)
Doubtful 25% of RVS
I (Partly plus 100%
 of the
unsecured
secured by
Portion
RVS)
(NOS less
RVS)
Doubtful
II (Fully 40% of net
secured byOutstanding
RVS)
40% of RVS
plus 100%
Doubtful
of the
II (Partly
Unsecured
secured by
Portion
RVS)
(NOS less
RVS)
100% of net
Doubtful III
Outstanding
100% of net
Loss
Outstanding

Calculation of Provision in Doubtful Asset

1. Advances covered by ECGC guarantee: In the case of advances

classified as doubtful and guaranteed by ECGC, Export Credit
Guarantee Corporation of India Limited (ECGC in short) provision
should be made only for the balance over the amount guaranteed by
the Corporation. 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 the Corporation and then provision made as
illustrated hereunder:

Example
Outstanding Balance Rs. 4 lakh
ECGC Cover 50 percent
Doubtful I D1 (say
Asset Classification as on March 31,
2024)
Value of security held Rs. 1.50 lakh

Provision required to be made:

Outstanding balance Rs. 4.00 lakh

Less: Value of security
Rs. 1.50 lakh
held
Unrealised balance Rs. 2.50 lakh
Less: ECGC Cover
(50% of unrealisableRs. 1.25 lakh
balance)
Net unsecured balance Rs. 1.25 lakh
Provision forRs. 1.25 lakh (@ 100
unsecured portion ofpercent of unsecured
advance portion)
Provision for securedRs.0.375 lakh (@ 25 percent
portion of advance of the secured portion)
Total provision to beRs.1.625 lakh (as of March
made 31, 2024)

2. Advance covered by CGTMSE: In case the advance covered by

CGTMSE guarantee becomes nonperforming, no provision need be
made towards the guaranteed portion. The amount outstanding more
than the guaranteed portion should be provided for as per the extant
 guidelines on provisioning for non-performing assets. An illustrative
example is given below:

Example

Outstanding
Rs. 10 lakh
Balance
75% of the amount outstanding or
CGTMSE Cover 75% of the unsecured amount,
whichever is the least
Asset Doubtful II D2 (say as on March
Classification 31, 2024)
Value of security
Rs. 1.50 lakh
held

Provision required to be made:

Balance outstanding Rs.10.00 lakh

Less: Value of security Rs. 1.50 lakh
Unsecured amount Rs. 8.50 lakh
Less: CGTMSE cover (75%) Rs. 6.38 lakh
Net unsecured and uncovered
Rs. 2.12 lakh
portion:
Provision for Secured portion @
Rs.0.60 lakh
40% of Rs.1.50 lakh
Provision for Unsecured &
uncovered portion @ 100% ofRs.2.12 lakh
Rs.2.12 lakh
Total provision required Rs.2.72 lakh

Standard Assets: Provision on Standard Assets is done as under;

(i) The provisioning requirements for all types of standard assets stand as below. Banks should
make general provisions for standard assets at the following rates for the funded outstanding
on a global loan portfolio basis:

1. Direct advances to agricultural and Small and Micro Enterprises (SMEs) sectors at 0.25
percent;

2. Advances to the Commercial Real Estate (CRE) Sector at 1.00 percent;

3. Advances to Commercial Real Estate – Residential Housing Sector (CRE – RH) at 0.75
percent;

4. Housing loans extended at teaser rates and restructured advances as per latest norms;

5. All other loans and advances not included in (a) (b) and (c) above at 0.40 percent.

(ii) The provisions on standard assets should not be reckoned for arriving at net NPAs.

(iii) The provisions towards Standard Assets need not be netted from gross advances but
shown separately as ‘Contingent Provisions against Standard Assets’ under ‘Other Liabilities
and Provisions Others’ in Schedule 5 of the balance sheet.

Takeout finance: The lending institution should make provisions against a ‘takeout finance’
turning into NPA pending its takeover by the taking-over institution. As and when the asset is
taken-over by the taking-over institution, the corresponding provisions could be reversed.