Provisioning for Loans and Advances
The RBI’s Master Circular of July 1, 2015 on Income Recognition, Asset Classification and Provisioning Pertaining to Advances contains the principles to be followed by the bank in calculating the provisions required for the NPAs in conformity with the prudential norms. The circular also requires the bank to take into consideration aspects such as time lag between an account becoming an NPA, its recognition as such, realisation of security and the erosion over time in the value of security charged to the bank, while calculating the required amount of provision. The specific requirements of the Master Circular in respect of provisioning are as follows:
(a) Loss assets
The entire amount should be written off. If the assets are permitted to remain in the books for any reason, 100 percent of the outstanding should be provided for.
(b) Doubtful assets
The provisioning for doubtful assets under loans and advances is as under:
(i) Full provision to the extent of the unsecured portion should be made. In doing so, the realisable value of the security available, to which the bank has a valid recourse, should be determined on a realistic basis. Auditor should verify whether that the security is considered based on the latest information available with the bank. DICGC/ECGC cover is also taken into account (this aspect is discussed in detail later in this Chapter).
(ii) In regard to the secured portion, provision may be made on the following basis, at the rates ranging from 25% to 100% of secured portion depending upon the period for which the asset has remained doubtful. In case the advance covered by CGTSI guarantee becomes nonperforming, no provision need be made towards the guaranteed portion. The amount outstanding in excess of the guaranteed portion should be provided for as per the extant guidelines on provisioning for nonperforming advances
| Period for which the advance has been considered as doubtful | % of provision on secured portion |
| Upto 1 year | 25 |
| More than 1 year and upto 3 years | 40 |
| More than three years | 100 |
Valuation of Security: With a view to bringing down divergence arising out of difference in assessment of the value of security, in cases of NPAs with balance of Rs. 5 crore and above, stock audit at annual intervals by external agencies appointed as per the guidelines approved by the Board is mandatory in order to enhance the reliability on stock valuation. Collaterals, such as immovable properties charged in favour of the bank are required to be got valued once in three years by valuers appointed as per the guidelines approved by the Board of Directors.
(c) Sub-standard assets
A general provision of 15% on total outstanding should be made without making any allowance for DICGC/ECGC cover and securities available. Unsecured exposures, which are identified, as sub-standard would attract an additional provision of 10%. (i.e., total 25% of total outstanding). However, in view of certain safeguards such as escrow accounts available in respect of infrastructure lending, infrastructure loan accounts which are classified as substandard will attract a provisioning of 20 per cent instead of the aforesaid prescription of 25 per cent. To avail of this benefit of lower provisioning, the banks should have in place an appropriate mechanism to escrow the cash flows and also have a clear and legal first claim on these cash flows. Unsecured exposure’ is defined as an exposure (including all funded and nonfunded exposures) where realisable value of the tangible security properly charged to the bank, as assessed by bank/approved valuers/RBI inspectors, is not more than 10%, ab initio, of the outstanding exposure. ‘Security’ means tangible security properly discharged to the bank and will not include intangible securities like guarantees (including State government guarantees), comfort letters, etc.
In order to enhance transparency and ensure correct reflection of the unsecured advances in Schedule 9 of the banks’ balance sheet, the following RBI requirements are applicable from the financial year 2009-10 onwards:
a) For determining the amount of unsecured advances for reflecting in schedule 9 of the published balance sheet, the rights, licenses, authorisations, etc., charged to the banks as collateral in respect of projects (including infrastructure projects) financed by them, should not be reckoned as tangible security. Hence such advances shall be reckoned as unsecured.
b) However, banks may treat annuities under build-operate-transfer (BOT) model in respect of road / highway projects and toll collection rights, where there are provisions to compensate the project sponsor if a certain level of traffic is not achieved, as tangible securities subject to the condition that banks’ right to receive annuities and toll collection rights is legally
enforceable and irrevocable.
c) It is noticed that most of the infrastructure projects, especially road/highway projects are user-charge based, for which the Planning Commission has published Model Concession Agreements (MCAs). These have been adopted by various Ministries and State Governments for their respective public-private partnership (PPP) projects and they provide adequate comfort to the lenders regarding security of their debt. In view of the above features, in case of PPP projects, the debts due to the lenders may be considered as secured to the extent assured by the project authority in terms of the Concession Agreement, subject to the following conditions
i) User charges / toll / tariff payments are kept in an escrow account where senior lenders have priority over withdrawals by the concessionaire;
ii) There is sufficient risk mitigation, such as pre-determined increase in user charges or increase in concession period, in case project revenues are lower than anticipated;
iii) The lenders have a right of substitution in case of concessionaire default;
iv) The lenders have a right to trigger termination in case of default in debt service; and
v) Upon termination, the Project Authority has an obligation of (i) compulsory buy-out and (ii) repayment of debt due in a predetermined manner.
In all such cases, banks must satisfy themselves about the legal of the provisions of the tripartite agreement and factor in their past experience with such contracts.
d) Banks should also disclose the total amount of advances for which intangible securities such as charge over the rights, licenses, authority, etc., has been taken as also the estimated value of such intangible collateral. The disclosure may be made under a separate head in “Notes to Accounts”. This would differentiate such loans from other entirely unsecured loans.
As per the existing instructions of RBI, in the Balance Sheet of the banks, the amounts comprising Debtors (though not tangible assets), charged as security are grouped as secured by tangible assets and disclosure is made with a remark in parenthesis in the Schedule 9, without any quantification of the advances covered by security of Debtors. The amounts comprising the intangibles as per the RBI’s Master Circular on Income recognition and Asset Classification Norms will need to be culled out of the secured exposures and quantified to be reflected as unsecured advances; which would also require corresponding reclassification of advances for the earlier year. More importantly, in case of NPAs, the unsecured portion would attract a higher provision, when segregated from the secured portion.
(d) Standard Assets
The bank is required to make a general provision for standard assets at the following rates for the funded outstanding on global loan portfolio basis. The general provision towards standard assets as per Master Circular is as follows:
a) Farm Credit to Agricultural and Small and Micro Enterprises (SMEs) sectors – 0.25%.
b) Advances to Commercial Real Estate (CRE) sector – 1.00%.
c) Advances to Commercial Real Estate – Residential Housing Sector (CRE – RH) at 0.75 per cent. For this purpose, CRE-RH would consist of loans to builders/developers for residential housing projects (except for captive consumption) under CRE segment. Such projects should ordinarily not include non-residential commercial real estate. However, integrated housing projects comprising of some commercial space (e.g. shopping complex, school, etc.) can also be classified under CRE-RH, provided that the commercial area in the residential housing project does not exceed 10% of the total Floor Space Index (FSI) of the project. In case the FSI of the commercial area in the predominantly residential housing complex exceeds the ceiling of 10%, the project loans should be classified as CRE and not CRE-RH.
d) Housing loans extended at teaser rates– 2.00%- The provisioning on these assets would revert to 0.40 per cent after 1 year from the date on which the rates are reset at higher rates if the accounts remain ‘standard’.
e) Restructured accounts classified as standard advances will attract a higher provision (as prescribed from time to time) in the first two years from the date of restructuring. In cases of moratorium on payment of interest/principal after restructuring, such advances will attract the prescribed higher provision for the period covering moratorium and two years thereafter.
Restructured accounts classified as non-performing advances, when upgraded to standard category will attract a higher provision (as prescribed from time to time) in the first year from the date of upgradation. As per para 17.4.1 of IRAC Norms, with effect from April 1, 2016 provision on new restructured standard accounts would be made at 5 per cent. The phased manner plan for increase in the provision to 5 per cent was in existence till March 31, 2016. All other loans and advances not included in (a), (b), (c), (d) and (e) above – 0.40%.
It is clarified that the Medium Enterprises will attract 0.40% standard asset provisioning. The definition of the terms Micro Enterprises, Small Enterprises, and Medium Enterprises shall be in terms of Master Circular on Lending to Micro, Small & Medium Enterprises (MSME) Sector.
While the provisions on individual portfolios are required to be calculated at the rates applicable to them, the excess or shortfall in the provisioning, vis-a-vis the position as on any previous date, should be determined on an aggregate basis. If the provisions required to be held on an aggregate basis are less than the provisions held as on November 15, 2008, the provisions rendered surplus should not be reversed to P&L account but should continue to be maintained at the level, existed as on November 15, 2008. In case of shortfall determined on aggregate basis, the balance should be provided for by debit to P&L account.
The provisions on standard assets should not be reckoned for arriving at net NPAs. The provisions towards Standard Assets need not be netted from gross advances but included as ‘Contingent Provisions against Standard Assets’ under ‘Other Liabilities and Provisions – Others’ in Schedule 5 of the balance sheet.
Banks shall make additional provision of 2% (in addition to country risk provision that is applicable to all overseas exposures) against standard assets representing all exposures to the step-down subsidiaries of Indian companies, to cover the additional risk arising from complexity in the structure, location of different intermediary entities in different jurisdictions exposing the Indian company, and hence the bank, to greater political and regulatory risk. All the step-down subsidiaries, including the intermediate ones, must be wholly owned subsidiary of the immediate parent company or its entire shares shall be jointly held by the immediate parent company and the Indian parent company and / or its wholly owned subsidiary. The immediate parent should, wholly or jointly with Indian parent company and / or its wholly owned subsidiary, have control over the step-down subsidiary.
A high level of unhedged foreign currency exposures of the entities can increase the probability of default in times of high currency volatility. Hence, banks are required to estimate the riskiness of unhedged position of their borrowers as per the instructions contained in RBI circular DBOD.No.BP.BC.85/21.06.200/2013-14 dated January 15, 2014 and circular DBOD. No. BP.BC.116/21.06.200/2013-14 dated June 3, 2014 and make incremental provisions on their exposures to such entities:
Likely Loss / EBID (%) |
Incremental Provisioning Requirement on the total credit exposures over and above extant standard asset provisioning |
Upto15 per cent |
0 |
More than 15 per cent and upto 30 per cent |
20bps |
More than 30 per cent and upto 50 per cent |
40bps |
More than 50 per cent and upto 75 per cent |
60bps |
More than 75 per cent |
80 bps |