March 18, 2023

IRAC Norms and Asset Verification

CA Suresh Agaskar
 Disclaimer

❖ Views expressed herein may not necessarily reflect the views of the firm.

❖ A presentation that raises ideas and concepts does not amount to an opinion of the firm or of the author but
should be merely viewed as matters having potential possibility.

❖ This presentation is intended for discussion only.

❖ A presentation is not a replacement for a formal opinion on a point of law which may require to be addressed.

❖ The information and views contained in this presentation are to be viewed with caution and should be
appropriately considered.

❖ Information provided herein is only for the benefit of the recipients, and is not to be shared with any other person
without our or ICAI consent

2
 Non-regulatory developments during FY 22-23

❖ Rising interest rates- improvement in operating income of banks, sustainability of same?;

❖ Lagging growth in deposits vis-à-vis credit growth – pressure on banks for liquidity – auditor to be watchful for
mis-selling;

❖ Recent layoff in the IT and other industries could bring some pressure on retail portfolio of bank- see portfolio
mix at branch;

❖ RBI focus on- asset quality, IT investments, functioning of DBU – recent discussions in meeting;

❖ Central Bank Digital Currency (CBDC)- counterfeit, cash management, cost saving etc.;- launch of e₹-R on pilot
basis from 1st December 2022- classification & treatment in FS

❖ Increased focus on responsibilities of regulated entities employing recovery agents- impact on overall recovery &
collection efficiency – could be area for LFAR reporting in case of any complaints/specific directions by RBI to
bank;

3
 Bank Branch Audit- recent development

❖ Coverage of advances: FY 2022-23:-

❖ FY 2023-24 onwards: coverage of branches under audit need to be determined as per Board approved policy –
impact on no. of branches

❖ Branch audit Fees: increase of 10% audit fees, Fees for LFAR & Certificate to be decided by management- impact
on total remuneration

❖ Prior approval of RBI: general permission to PSBs for appointment/re-appointment of SBAs- no need for prior
approval from RBI

❖ Branches per firm- maximum two branches each SBA(earlier three branches)- opportunities for more firms

4
 Challenges for Bank Audit -FY 2022-23

❖ IRAC Norms 2.0- reporting on implementation issues in - daily NPA classification through system with minimum
or no manual intervention, out of order in CC a/c etc. as per new norms

❖ COVID-2.0- Restructuring Scheme- Post implementation compliances including classification on account as NPA
– date of NPA

❖ Monitoring pool of restructured account- accounts under various restructuring schemes with different criteria
for upgradation etc.

❖ Retail loan portfolio- increase in interest rates leads to increase in the default risk which may lead to possible
evergreening & negative amortisation

❖ Certificates & reporting- reasons for limited assurance in the certificates & reporting on process of internal
weakness in critical process

5
 Challenges for Bank Audit -FY 2022-23

❖ Certificates: (SCA/SBA)

❖ Reporting- (SCA)

6
 Relevant Circulars applicable for FY 2022-23

Master Circular/Master Directions:

❖ Master Circular Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to
Advances April 2022– New Changes [Consolidated Circular]

❖ Master Directions on Frauds – Classification and Reporting by commercial banks and select FI- July 2017- RFA &
EWS mechanism

❖ Master Direction-Priority Sector Lending-Targets and Classification (amended from time to time)- Certificate from
SBA’s

❖ Master Direction - Know Your Customer (KYC) Direction, 2016- LFAR clauses

❖ Master Circular - Guarantees and Co-acceptances

7
 Relevant Circulars applicable for FY 2022-23

Other Circular/Notifications:

❖ Master Direction on Financial Statements - Presentation and Disclosures (amended time to time)- mainly for SCAs

❖ Master Direction – Reserve Bank of India (Regulatory Framework for Microfinance Loans) Directions, 2022-
effective from April 01, 2022

❖ Consolidated Circular on Opening of Current Accounts and CC/OD Accounts by Banks dated April 19,2022 - LFAR
Reporting

❖ Master Direction – Reserve Bank of India (Securitisation of Standard Assets) Directions, 2021- mainly for SCAs

❖ Master Direction – Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021- mainly for SCAs

8
 Relevant Circulars applicable for FY 2022-23

Other Circular/Notifications:

❖ Automation of NPA- Classification & Provision- September 14, 2020

• To be implemented by 30th June,2021;
• Manual intervention- on classification & provisioning to be removed;
• NPA classification to be made as day-end process- Daily NPA;
• System should be audited by independent expert

❖ Reserve Bank of India (Financial Statements - Presentation and Disclosures) Directions, 2021 - Disclosure of
Divergence in Asset Classification and Provisioning- October 11, 2022- mainly for SCAs

❖ Reserve Bank of India (Financial Statements - Presentation and Disclosures) Directions, 2021 - Disclosure of
material items- December 13, 2022 -mainly for SCAs

❖ Outsourcing of Financial Services - Responsibilities of regulated entities employing Recovery Agents-August 12,
2022

9
 ICAI Materials

10
 Changes in presentation of FS of Banks/BC

❖ Disclosure of divergence in Asset classification & provisioning:

Threshold 2021-22 2022-23 2023-24
Additional provisioning for NPAs to reported 10% 10% 5%
profit before provisions and contingencies

Additional Gross NPAs identified to reported 15% 10% 5%

incremental Gross NPAs

❖ Disclosure of Material items:

• Other Liabilities- Any item under the “Others (including provisions)” exceeds one per cent of the total assets,
particulars of all such items shall be disclosed in the notes to accounts
• Other Assets- Where any item under “Others” exceeds one per cent of the total assets, particulars of all
such items shall be disclosed in the notes to accounts

11
 Changes in presentation of FS of Banks/BC

❑ Example- ABC Bank Limited:

Threshold For 2021-22
(in Cr.)
Additional NPA -PTC Investments 67.00
Additional Provisioning on above 17.00
Profit before provisions and contingencies 7,262.18
Reported incremental Gross NPAs [only loans & no investments was 954.05
classified as NPA]

❖ In your view whether ABC Bank required to disclose the above divergence in their Notes to accounts?

❖ What will be the situation in FY 2023-24 considering the similar figures?

12
 Journey of IRAC 2.0

Automation of IRAC IRAC

IRAC Norm
IRACP process Clarification Clarification IRAC Norm
October 1,
September 14, November 12, February 15, April 1, 2022
2021
2020 2022 2022

13
 NPA Automation Circular, September 14, 2020

Coverage:
2.1 All borrowal 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.
2.2 Asset classification rules shall be configured in the System, in compliance with the regulatory stipulations.
2.3 Calculation of provisioning requirement 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.
2.4 In addition, income recognition/derecognition in case of impaired assets (NPAs/NPIs) shall be system driven and
amount required to be reversed from the income account should be obtained from the System without any manual
intervention.
2.5 The System shall handle both down-grade and upgrade of accounts through Straight Through Process (STP)
without manual intervention.

14
 Changes in IRAC norms, October 1, 2021

❖ Earlier requirements:

❖ New requirements: [October 2021 circular]

15
 IRAC Norms – Clarifications, November 12, 2021

Major points of clarifications

❖ Specification of due date/repayment date in loan agreement

❖ Classification of SMA & NPA –part of day-end process (Same Day vs. Next Day)

❖ Clarification regarding definition of ‘out of order’

❖ NPA classification in case of interest payments

❖ Income recognition policy in case of loans with moratorium on interest

16
 IRAC Norms – Clarifications, November 12, 2021

❖ Classification of SMA & NPA –part of day-end process:

17
 IRAC Norms – Clarifications, November 12, 2021

Classification of SMA & NPA –part of day-end process:

Due date Overdue date SMA NPA

31/03/22 01/04/22 01/04/22 30/06/22

Due date Overdue date SMA NPA

31/03/22 31/03/22 31/03/22 29/06/22

❖ Different banks were following different practice of identification of account as NPA- monthly/quarterly/daily
❖ September 2020 circular and November 2021 circulars now requires SCB to identify the NPA on daily basis through
system- June 2021
❖ No exceptions are given for Saturday/Sunday/Holidays- NPA process need to run to identify any account as NPA-
LFAR point
❖ Major impact- total overdue recovery for NPA vs. Partial recovery in Standard accounts

18
 IRAC Norms – Clarifications, November 12, 2021

❖ Clarification regarding definition of ‘out of order’:

Changes in the wording of definition:

3
19
 IRAC Norms – Clarifications/changes for Banks

❖ Clarification regarding definition of ‘out of order’:

Existing practice for classification of account as NPA- under 3rd condition- quarterly basis:
Testing 3rd condition for quarter ended 31st December 2022:
Months Interest Debits Credits Credits
(Scenario A) (Scenario B)
July 15 15 15
August 20 0 0
September 21 0 0
October 10 10
November 10 10
December 10 25

Scenario- A Scenario- B
Total Debits-56 Total Debits-56
Total Credits-45 Total Credits-60
Conclusion- NPA Conclusion- STD
20
 IRAC Norms – Clarifications/changes for Banks

❖ Clarification regarding definition of ‘out of order’:

Clarification –view-1- Daily NPA classification-Previous 90 days period’ :

Testing 3rd condition for quarter ended 31st December 2022:
Dates Interest Debits Credits Previous 90 days
31-07-2022 13 02-05-2022
02-08-2022 13 04-05-2022
31-08-2022 11 02-06-2022
02-09-2022 11 04-06-2022
30-09-2022 12 02-07-2022
02-10-2022 12 04-07-2022
31-10-2022 13 02-08-2022
01-11-2022 0 03-08-2022

On 31-10-2022
PR 90 days Debits-36 On 01-11-2022
PR 90 days Credits-36 PR 90 days Debits-36
21 Conclusion- STD PR 90 days Credits-23
 IRAC Norms – Clarifications/changes for Banks

❖ Clarification regarding definition of ‘out of order’:- View-1

❖ Circular requires that credits in the account should be able to cover the interest debited during the previous 90
days period;

❖ Post September 2020 circulars all the banks are required to run the NPA on “Daily basis”- therefore each day
3rd condition of the circular will be tested by the bank to classify an account as NPA.

❖ In view-1-

❖ 31st October 2022- as part of day end process for 31st October- the system will consider all the credits &
debits since 2nd August 2022 i.e., previous 90 days- in example sufficient recovery & hence it will STD account.

❖ 1st November 2022- here the previous 90 days will start from 3rd August and hence recovery made on 2nd
August 2022 will not be covered & therefore it may be NPA account.

22
 IRAC Norms – Clarifications/changes for Banks
❖ Clarification regarding definition of ‘out of order’:

Clarification –view-2- Daily NPA classification-Previous 90 days period’ :

Testing 3rd condition for quarter ended 31st December 2022:
Dates Interest Debits Credits DPD
31-07-2022 15 1
01-08-2022 - 2
02-08-2022 15 0
31-08-2022 11 1
01-09-2022 - 2
02-09-2022 11 0
30-09-2022 12 1
01-10-2022 - 2
02-10-2022 12 0
31-10-2022 13 1
01-11-2022 0 2

23
 IRAC Norms – Clarifications/changes for Banks

Clarification regarding definition of ‘out of order’:

❖ Circular requires that credits in the account should be able to cover the interest debited during the previous 90
days period- which can be interpreted as interest should not remain overdue for 90 days;

❖ In this view- interest charged in the CC account will be treated as demand created in the account and if there are
no credits within 90 days the account will be treated as out of order.

❖ The view removes the difference between term loans and CC facility w.r.t. interest recovery- however it still
differentiate between the two by way of credit in the account vs. one way recovery in term loans.

❖ Different views/approach adopted by different bank in following 3rd condition of out of order.

24
 CS-1-Quality of Credit in CC accounts :

❖ ABC Pvt. Ltd. has availed CC facility from the bank. The bank has closed current account with borrower as per new
RBI guidelines. The company has also taken Rupee Term Loan and Capex LC was sanctioned as sub-limit to this
facility. The company had taken LC against the capex expenditure and on due date of LC the bank had disbursed
RTL to close these LC’s.

❖ The disbursement against the capex LC were routed through the CC/OD account and the payment were made
from this account itself. The account is classified as Standard based on out of order criteria [credits are sufficient].

❖ On careful verification of the account statement, the auditor has observed that the business credits in the account
were not sufficient to cover the interest debited during the period of previous 90 days. However, the system had
classified the account as STD considering the disbursement credits in the CC/OD account.

❖ As an auditor what is your view on such practice and compliance with IRAC norms.

25
 CS-1-Quality of Credit in CC accounts :

❖ Consolidated Circular on Opening of Current Accounts and CC/OD Accounts by Banks- April 19, 2022

26
 CS-1-Quality of Credit in CC accounts :
❖ Following is account extract of XYZ Limited CC Account:

❖ No credit entry in account post 31st August 2022 & the bank has classified the account as NPA on 29th November
2022 (90 days) due to non-service of interest.

❖ As an auditor what is your view on the above and compliance with IRAC norms.
27
 IRAC Norms – Clarifications/changes for Banks:

Clarification regarding interest during moratorium period:

❖ Mainly applicable for Educational loans- where accrued interest during the repayment holiday period is added to
the principal and repayment in Equated Monthly Instalments (EMI) fixed.

❖ Different views among the auditors/banks on treatment of the above interest once the account is classified as
“NPA”.

28
 IRAC Norms – Clarifications, February 15, 2022:

Major points of clarifications – 15th February 2022 circular:

❖ Out of order- applicable to all loan products being offered as an overdraft facility

❖ Previous 90 days period- inclusive of the day for which the day-end process is being run- IMP clarification

❖ Upgradation of the facility-only upon repayment of entire arrears of interest and principal pertaining to all the
credit facilities- IMP clarification

29
 CS-2-Linked account upgradation:

❖ Mr. A, customer of ABC Bank Limited is having 3 facility with the bank.
Facility O/s in Rs. Status as on 29th Status as on 11th
November March 2023
Personal Loans 5,00,000 30 days DPD 81 days DPD
Housing Loan 59,00,000 90 days DPD Nil DPD
Auto Loan 15,00,000 Nil DPD 30 days DPD

❖ The Housing loan account of the customer was overdue and was classified as NPA on 29th November 2022. On
11th March 2023 the customer has paid entire overdues of the housing loan and DPD in other loans are below 90
days.
❖ The bank on 11th March 2023 has upgraded the housing loan from NPA to standard and all other account
automatically upgraded to standard account.
❖ As an auditor what is your view on such practice and compliance with IRAC norms.

30
 IRAC Norms – Clarifications

Major points of clarifications –Upgradation of loan account:

1st October 2021 IRAC norms:

1st April 2022- IRAC Norms: (added by 15/02 clarification)

31
 Recent RBI Divergence/observations:

❖ Non-implementation of RP-7th June 2019:

▪ Defaults not rectified within the review period of 30 days or viable RP not implemented within 180 days
▪ Additional provision made only on FB exposure portion and not on total o/s amount (FB+NFB)

❖ DP computed based on the expired stock statements- to be classified as NPA

❖ Wrongful upgradation of NPA accounts before implementation of restructuring plan

❖ Wrongful reversal of provision on change in ownership before expiry of monitoring period

❖ Realisable value of security less than 10% of o/s- not classified as Loss assets – only in NPA cases

❖ Rollover of Working Capital Demand Loan (WCDL) of a borrower under financial difficulty tantamount to
restructuring – Cash Credit

❖ Wrongful upgradation of investment exposure without ensuring satisfactory performance after writing off
advances

32
 Probable Expectation of RBI from Bank Auditor :

❖ Identification of probable evergreening of accounts by the banks

❖ Reporting on non-compliance of IRAC norms- identification of account (e.g. restructured a/c) and provisioning
(e.g. no security)

❖ Extra care or additional audit procedure on restructured accounts- MSME + Non-MSME

❖ Basis compliance of IRAC norms – upgradation of accounts from NPA to Standard

❖ Assess increase in credit risk- pervasive in nature- identify through QMR reports etc.

❖ Highlighting the areas of two different view/interpretation issues through LFAR

33
 Types of Assets:

Standard Assets:
❖ The account/borrower is regular in paying the interest and the principal as and when due/demanded by the Bank.
❖ Normal risk and the provisioning on these advances depends on the category of the loans

Non-Performing Assets:
❖ Para 2.1.1. “An asset, including a leased asset, becomes non performing when it ceases to generate income for the
bank”
❖ Only recovery need to be seen to classify an account as NPA
❖ No distinction between Secured and Unsecured assets for the purpose of the classification of account

34
 Criteria for classification- NPA

Sr. No. Type of Facility Criteria –Para 2.1.2

(A) Term Loans “interest and/or instalment of principal remain overdue for a period
of more than 90 days in respect of a term loan”

(B) Overdraft/Cash Credit “the account remains ‘out of order as indicated in the IRAC
Out of Order- para 2.2
▪ Outstanding Balance > SL or DP continuously for 90 days
▪ No credits in accounts continuously for 90 days as on B/s date
▪ Credits in the accounts are not sufficient to cover interest debited
during the same period the previous 90 days period

35
 Criteria for classification- NPA

Sr. No. Type of Facility Criteria –Para 2.1.2 & 4.2.21

(C) Bills Purchased & “the bills remain overdue for a period of more than 90 days “
Discounted
Overdue – any credit facility is overdue if it is not paid on the due date
fixed by the bank
(para 2.3)
(D) Credit Cards “if the minimum amount due, as mentioned in the statement, is not
paid fully within 90 days from the payment due date mentioned in the
statement”

(E) Derivative Transactions “overdue receivable representing positive M-t-M value of derivative
contract remains unpaid for more than 90 days”

36
 Criteria for classification- NPA

Sr. No. Type of Facility Criteria –Para 2.1.2 & 4.2.21

(F) Agricultural Advances ▪ Short duration crop- if the instalment of principal or interest thereon
remains overdue for two crop season;

▪ Long duration crop- if the instalment of principal or interest thereon

remains overdue for one crop season;

▪ Crop season is decided by State Level Banker’s committee

37
 Classification of NPA: Asset Classification

Sub-Standard Assets: (SSA)

✓ Account has remained NPA for a period less than or equal to 12 months

Doubtful Assets:
✓ Account has remained SSA category for a period of 12 months- DB-1
✓ Account has remained in DB-1 for 1-3 years –DB-2
✓ Account has remained in DB-2 for more than 3 years-DB-3

Loss Assets:
✓ Identified by the bank or internal or external auditor or the RBI inspection

SA-SSA-DB1-DB2-DB-3

38
 CS-3-Evergreening through group co’s:

❖ ABC Pvt. Ltd. is a company registered under CA, 2013. The company is 100% subsidiary of XYZ Ltd. ABC Pvt. Ltd.
has taken Rs. 20 cr. Loan from KNK Bank and is serving interest on regular basis. These funds have been utilised to
construct a factory which has started it commercial production, however the market for the product has declined
considerably. The principal amount for November 2022 and December 2022 is due. During the current year, KNK
bank has sanctioned a loan facility to XYZ Ltd. for cash flow mismatch .

❖ Post granting of such facility XYZ Ltd. has made inter-corporate deposit to ABC Pvt. Ltd @ 12%. The overdue in the
account has been fully paid by the ABC Pvt. Ltd.

❖ Both the account has been classified as Standard as on 31st March 2023.Comment on appropriateness of the
classification of advances.

39
 CS-4-ECLGS Evergreening:

❖ The bank has sanctioned ECLGS facility to ABC co. under ECLGS 1.0 extension scheme. The sanction was as per the
limit prescribed under the scheme and after complying with the eligibility criteria. Another group entity of the
borrower XYZ Co. had also applied for the ECLGS facility but the same was rejected by the bank since the customer
was ineligible as per the scheme.

❖ On verification, the auditor observed that after the disbursement of ECLGS facility to the borrower the amount
disbursed in the account has been transferred to CC a/c of XYZ co. and the bank has utilised the same to recover
its pending overdues.

❖ Post cleaning of dues, the CC facility of the borrower was renewed with enhancement. The enhanced amount was
transferred from CC to ABC co. CC account. The ECLGS facility was closed through such disbursement.

❖ As an auditor what is your view on such practice and appropriate reporting in Advance section of LFAR?

40
 CS-5-Evergreening-additional funding:

M/s K.C. & Co. has two facilities with XYZ Bank Ltd. CC/OD facility of INR 5 cr. and General Business Purpose Term
Loan of INR 10 cr. (disbursed to the extent of INR 8 cr.).

As on February 2023, the CC/OD facility is out of order and will be classified this account as NPA as on March 31,
2023. During the month of March-2022, M/s K.C. & Co. requested for additional disbursement of the loan to the
extent of INR 2cr.

On 28th March 2023 the firm repaid the overdue amount in the CC/OD facility and the account is regular as on 31st
March 2023.

During statutory audit, the auditor raised an objection stating that the account has been regularised by sanctioning
an additional facility to the borrower and this account should be classified as NPA as on 31st March 2023

41
 CS-6-Negative amortisation:

Mr. A has taken housing loan from ABC Bank Ltd. and has been servicing EMI regularly on monthly basis. Due to
increase in the repo rate, the interest rate of the loan has increased significantly as compared to earlier. The extract of
the HL-statement is as follows:

Date Particulars Dr. Cr. Closing Amt.

01/01/2023 Opening Balance 11,00,000
31/01/2023 Interest for January 10,000 11,00,000
31/01/2023 Recovery 9,500 11,00,500
28/02/2023 Interest for February 9,800 11,10,300
28/02/2023 Recovery 9,500 11,00,800

In the above example, the recovery is not sufficient to cover the interest portion as well the principal o/s is increasing
on monthly basis. The bank has not rescheduled the EMI and therefore Rs.800 interest demand is unserved. Should
the account of Mr. A be classified as NPA on expiry of 90 days?

42
 CS-7-Form over Substance:

M/s XYZ & Co. (Mr. X & Mr. Y only partners of the firm are brothers) has following facility with ABC Bank Ltd. Term
Loans- INR 5 Cr, CC/OD facility- INR 3 cr. Both the partners are also having housing loan with the bank. The cumulative
o/s of such loans are INR 2 cr. The CC/OD facility of the firm has been classified as out of order due to continuously
overdrawn for more than 90 days. There is no other business activity carried out by the partners of the firm.

The statutory auditor is of the view that the housing loan of partners of the firms should be classified as NPA and the
bank should make provision on such loans as well. Whether the auditor is justified in classifying these advances as
NPA?

Will your answer differ if this is the case of proprietor firm- where CC facility is given in the name of proprietor firm
and housing loan in individual capacity. Cust-ID of both these loan accounts are different in system?

43
 Classification of Co-borrower: [Industry Issue]

Assessment of Joint Loans:

❖ Loans given after assessing and considering income of primary and co-borrower;
❖ Eligibility criteria tested considering the profile of both the borrowers;
❖ Borrower and Co-borrower – equal responsibility in regular service of EMI;
❖ Default in repayment by both would lead to account getting classified as overdue and then NPA.

Current Industry practice:

❖ In absence of clear guidance- only Cust ID of primary borrower is classified/tagged as NPA- Co-borrower only CIBIL
Borrower Housing Loan Auto Loan Credit Card
Primary Rs.10 crore Rs. 50 lakhs
Co-borrower (Joint Loan) - Rs.5 lakhs
NPA Yes Yes ???
Classification

44
 Classification of Co-borrower:

IRAC norm- 1st April 2022:

❖ No specific guidance on classification of co-borrower in case joint facility becomes an NPA;
❖ Joint responsibility of repayment - Default by one to be constituted as default by other;
❖ Term ‘borrower’ in IRAC norms would mean to include ‘co-borrower’ as there is no visible distinction between the
two;
❖ Both the borrowers to be classified as NPA.

Current Practice in some banks:

❖ ICICI Bank-

❖ Axis Bank-

45
 Classification of Co-borrower:

Approach for classification of Co-borrower:

❖ Co – applicant(s) will be classified as NPA, if any of the facilities of the primary applicant have been classified as
NPA; [‘any’ vs. joint facility could be debated]

❖ All the other Linked facilities of the co- applicant where he/she is the primary/sole applicant will also be classified
as NPA

❖ Percolation impact on co - applicant(s) being classified as NPA shall trigger only when the primary applicant
identify as NPA and/or Upon Fraud classification of primary applicant

❖ Percolation impact to co – applicant(s) shall be restricted up to one level only

❖ If the co - applicants have been identified as NPA, it will not trigger NPA Classification of the primary applicant(s)
[reverse way]

46
 CS-8- Classification of Co-borrower:

Loan A B C D
Housing Loan - NPA Primary Co-Applicant - -

Auto Loan Primary - Co-Applicant -

Credit Card - Sole - -
Personal Loan - - Sole

Mortgage Loan - - Primary Co-Applicant

Personal Loan - - - Sole

NPA Classification ?? ?? ?? ??

47
 Exemption from NPA Classification

Para 4.2.11 of IRAC Norms:

❖ 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.

Para 4.2.14 of IRAC Norms:

❖ The credit facilities backed by guarantee of the Central Government though overdue may be treated as NPA only
when the Government repudiates its guarantee when invoked.

48
 Provisioning Norms:

Sr. No. Asset class (NPA) Provisioning %

(A) Normal Category:
Sub-Standard Assets (Fully Secured) 15%
Sub-Standard Assets (Unsecured) 25%

Unsecured exposure:
“Realisable value of security is not more than 10% of the outstanding exposure”

Infrastructure Category:
Sub-Standard Assets (Fully Secured) 15%
Sub-Standard Assets (Unsecured) 20%

(B) Doubtful Assets:

DB-1 (Upto 1 Year) 25%
DB-2 (1 to 3 Year) 40%
DB-3 (More than 3 Year) 100%

49
 Provisioning Norms:

Sr. No. Asset class (NPA) Provisioning %

(C) Loss Assets 100%
(D) Standard Assets:
▪ Direct Advances to Agriculture and SME Sector 0.25%
▪ Advances to Commercial Real Estate (CRE)
▪ Advances to CRE- Residential Housing (CRE-RH) 1.00%
▪ Housing Loan at Teaser rates (+ 1 Year) 0.75%
▪ Restructure Advances (Other than Provision for Dim. In Value)
▪ All other loans not included in above 2.00%
5.00%

0.40%
Accelerated provisioning:
SMA status of accounts need to be reported to CRISIL-fails to report such status the bank will be subjected to
accelerated provisioning (SSA- to the extent of 40% and DB to the extent of 100% in DB-2 category )

50
 Issues in Classification of advances as NPA:

Erosion in value of security/Frauds by borrower:

❖ In Certain circumstances the NPA are classified directly to Doubtful/Loss assets

❖ Potential threat of recovery due to erosion in value of security or non availability of security and existence of other
factors (e.g. Frauds)

❖ Following classification policy should be adopted:

Case Situation – Realisable value of Security Classification
(A) Less than 50% (last assessed ) DB
(B) Less than 10% (of balance o/s) Loss

❖ New LFAR Clause- Substantial deterioration in Security Value

51
 RBI on Security Valuation:

Para 4.2.9 of IRAC Norms:

❖ In respect of accounts where there are potential threats for recovery on account of erosion in the value of security
or non-availability of security and existence of other factors such as frauds committed by borrowers it will not be
prudent that such accounts should go through various stages of asset classification.

Para 5.3 of IRAC Norms:

❖ 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.

52
 CS-10-Realisable value:

Mr. XYZ has taken housing loan from the bank for an aggregate amount of INR 5 cr. He has not paid the installment
and was classified as NPA, since year 1. The loan account is in DB-1 category with an outstanding amount of INR 4.3
cr. The bank currently has done the valuation of the property and the details of the same are as follows:

Date of Valuation Market Realisable Distress

Value Value Value
21-02-2021 INR 4.5 cr. INR 4.2 cr. INR 4 cr.

In January 2023, the bank has carried out the auction of the property at Base price of Rs.4.2 crore. However, no bid
was received towards the auction.

The bank has made provision @25% on the total outstanding balance considering the value of INR 4.5 cr. as on 31st
March 2023.

Comment on the adequacy of the provision on the above case.

53
 CS-11-Realisable value:

ABC Pvt. Ltd. has been classified as Non-Performing Asset in the earlier year. During the current year, the security
valuation considered for making provision has been arrived at valuation report which is 2-year-old.

However, the auditor observed that latest audited financial statement of the borrower includes impairment loss
against such assets. These impairment losses have been arrived at on the basis of the independent valuation
obtained by the company.

The provision for the NPA has been considering the old report since the same not more than 3 years old.

Further, the bank has also considered claim of ECGC as security on the application made to the department. The
approval of such claim is still awaited from the department.

Comment on the adequacy of the provision in the above case.

54
 CS-12-Existence of security:

AZB Bank has sanctioned a facility in FY 2020-21 of Rs. 5 crore to Mr. B for the purpose of buying a flat in an under-
construction property in Noida (20th Floor). The value of the property at the time of sanctioning of Loan is Rs. 8 cr.

The bank has disbursed Rs.3 crore up to 31st July 2022 based upon the completion of the construction of the building
on overall basis. However, the civil structure of the building has been completed up to 18th floor and the
construction work has been stopped by the local authorities. The builder is also having a financial difficulty for
commencing the construction and completing the same.

The account has become NPA as on 31st March 2023 and the has been classified as SSA. The bank has made 15%
provision on the same.

Whether in your view such classification and provisioning are as per IRAC norms.

55
 CS-13-Existence of security:

XYZ Bank has classified Q-real estate Pvt. Ltd. as NPA and the account is in DB-2 category. The total exposure is Rs.15
crore and the same is considered as fully secured against the residential units.

However, based on review of the valuation reports the auditor noted following comments in the same:

The bank has considered all the units including the above units sold without obtaining NOC as security for the
purpose of provision.

Whether in your view such provisioning are as per IRAC norms.

56
 CS-14- IBC Valuation:

XYZ Pvt. Ltd.is classified as NPA and is currently under DB-2 category. The lenders have filed case under IBC and the
resolution plan-liquidation has been accepted by the NCLT and the court has passed the order on 3rd March 2023.
Based on the same, the bank is expected to receive only 10% against its exposure.

However, on verification of NPA the auditor has observed that the bank has continued to consider value as per latest
available valuation report for making provision as per IRAC norms. On discussion, the branch manager is of the view
that these reports are system generated and value has been arrived based on CBS system.

Whether in your view such provisioning are as per IRAC norms.

57
 CS-15- P&M based on valuation reports:

ABC Pvt. Ltd. has been classified as NPA and is currently under DB-1 category as on 31st March 2023. The bank has
charge on P&M and Land & Building of the company. The bank has obtained separate valuation reports for P&M and
Land & Building in February 2021.

Based on the above, the bank has considered the realisable value of the security for the purpose of provision as on
31st March 2023.

The auditor is of the view that the practice of considering the value of P&M based on two-year-old valuation report is
not correct. These P&M are depreciable assets and therefore the value as on 31st March 2023 will be lower as
compared to value as per valuation report of February 2021.

Do you agree with the view of the auditor? If yes, what will be the alternate way to arrive at the value for the
provision purpose?

58
 RBI on Security Valuation:

S Types of Advances Types of Security available Impact

N
1 Standard Advances ▪ Immovable and Movable Assets (P & M, ▪ Schedule-9- Secured and
Inventories etc.); Unsecured Loans;
▪ Shares and Securities; ▪ Para 4.2.9 of IRAC Norms;
▪ Fixed Deposits and other liquid security (LIC, ▪ Para 4.2.11 of IRAC Norms;
KVP, NSC etc.)
▪ Guarantee by Govt./Promoter/Corporate ▪ Para 4.2.14 of IRAC Norms
2 Non-performing ▪ Immovable and Movable Assets (P & M,
Assets (NPA) Inventories etc.);
▪ Shares and Securities; ▪ Para 4.2.9 of IRAC Norms;
▪ Fixed Deposits and other liquid security (LIC, ▪ Para 5.3 of IRAC Norms
KVP, NSC etc.)
▪ Guarantee by Govt./Promoter/Corporate

59
 Income Recognition & Reversal on NPA:

❖ Interest income on NPA not recognised on accrual basis- against the principal of certainty of collection as AS-9-
Revenue Recognition

❖ Interest income on such accounts should be recognised on “Cash basis "or “Actual receipt” basis

❖ Exceptions:- Interest on advances against TD/KVP/NSC etc. subject to availability of Margin

❖ Advance, including bills purchased and discounted, becomes NPA, the entire interest accrued and credited to
income in past period should be reversed if the same is NOT REALISED.

❖ Fees, commission 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.

60
 CS-16-Income Reversal:

❖ During the year, PQR Pvt. Ltd. has been classified as NPA since the credits in the account were not able to cover
the interest debited in the accounts.

❖ On verification of the account statement the auditor observed that the bank has charged Rs.20,00,000 as Bank
Guarantee commission in the account, however the same has not been recovered by the bank but recovered
through unutilised limit in the account.

❖ The account is classified as Sub-Standard Account as on 31st March 2023.

❖ The auditor insisted on reversal of such fee's income; however, the bank is of the view that the said commission
have been realised through unutilised limit in the CC account and hence should not be reversed.

❖ Comment on the compliance of IRAC norms w.r.t. accuracy of such commission income.

61
 Upgradation of NPA Account:

❖ If arrears of interest and principal are paid by the borrower in case of loan accounts classified as NPA, the account
should no longer be treated as non-performing and may be classified as “Standard” accounts.

❖ Standard accounts classified as NPA and NPA accounts retained in the same category on restructuring by the bank
should be upgraded only when ALL the outstanding loan/facilities in the account perform satisfactorily during
the specified period i.e. principal and interest on all facilities in the account are serviced as per terms of payment
during that period.

❖ Comparison of NPA accounts/ critical accounts over a period- may highlight some serious concern over
Upgradation of NPA account during a particular period

62
 Recoveries in NPA Account:

❖ Recoveries before Balance Sheet date:

▪ Interest realised on NPA’s may be taken to income account provided credits in the accounts towards interest
are not out of fresh/additional credit facilities sanctioned to borrower by the bank.
▪ No formal guidelines/agreement between bank and borrower w.r.t. apportionment of recoveries made- bank
should adopt an accounting principle and exercise the right of appropriation of recoveries in uniform and
consistent manner.

❖ Recoveries after Balance Sheet date:

▪ No clear guidelines by the regulator- no adverse remarks on diverse practices followed by the Bank
▪ AS-4 Events occurring after the Balance Sheet date- Non adjusting event
▪ Temporary vs. Permanent deficiencies/weakness
▪ Best Judgement after review of facts and circumstances of each case

63
 CS-17- Appropriation policy:

XYZ Bank Limited has adopted following policy for the purpose of appropriation of recovery:

Standard a/c NPA a/c

Charges Principal
Penal Interest Interest
Interest Penal Interest
Principal Charges
The policy further states that the above policy should be followed uniformly across all the loan products.

The auditor is of the view that the above policy is practically not implemented at the ground in case of one of the
product.

In your view, if there any product & if yes please identify the same. Further How you will report in LFAR on the same?

64
 Practical Issues/Challenges:

❖ Divergence in NPA observed by RBI during the Inspections

❖ System based classified – sometime leads to incorrect classification (GIGO rule)

❖ Verification of parameters set in the system for classification of account as NPA (e.g. Repayment Schedule)

❖ Co-borrower classification – not implemented by the banks in system

❖ Non reversal of total interest in account classified as NPA (CY + PY unrealised)

❖ Recognition of interest income in NPA A/c’s

❖ Non submission of Stock Statement by small borrowers.

65
 Practical Issues/Challenges:

❖ Carry forward of date of NPA (from earlier year to current year)

❖ Classification of accounts qua borrower would apply for agricultural and non agricultural loans?

❖ Classification of accounts transferred from other branches

❖ NPA regularised after balance sheet date but before signing the accounts

❖ Income Leakage- Rate of Interest fed in system is incorrect, DP is wrongly calculated, penal interest not recovered
on late submission of Stock statements and Financials etc

66
 Audit Approach:

❖ Automated classification of NPA- verify system, parameters, controls on modification of parameters, control on
categorisation of NPA

❖ CC/OD/WC facility- verify the computation of drawing power, fresh sanction to escape the NPA classification, stock
statement submission with the latest Balance Sheet.

❖ Reversal of unrealised interest on first time classification and subsequent transfer to memorandum account

❖ Borrower wise classification, Upgradation, and subsequent down gradation of NPA accounts are as per IRAC
Norms

❖ Valuation of Security of main NPA cases- above a certain threshold determined by the Bank.

❖ No debits allowed in the NPA Accounts (e.g. Legal Charges debit separately )

67
 Minimum Audit Procedures on NPA:

❖ Comparison of NPA of current year vs. Previous year [ Name of Customer, Date of NPA, O/s Balance etc.]

❖ Verification of the any changes in the above and reasons for the same along with relevant supporting documents

❖ Increase in the O/s Balances- due to recovery charges etc. should be debited to P & L A/c- CRIP Cost in case of IBC
cases

❖ Verification of the recovery in the NPA accounts- apportionment as per the recovery policy of the bank-
adjustment of recoveries done through suspense a/c rather than direct NEFT/RTGS

❖ Verification of the security valuation for the cases shifted to Doubtful category in the current year from the date of
NPA

❖ Verification of Fraud accounts – comparison of the same with the last year and new accounts identified in the CY

68
 Key areas in NPA during Bank Audit-2022-23:

❖ Linked account upgradation from NPA to standard category

❖ Quality of credits in CC account considered for testing 2nd /3rd condition

❖ Possible evergreening through new facility to clear overdues in existing stress account

❖ Form over substance- classification of account under different legal entity

❖ Co-Borrower classification post classification of joint loan as NPA

❖ Security – existence of security & valuation for provision purpose

❖ Downgrade of Restructured account – Post COVID era- backdated NPA

❖ Revised EMI/Negative amortization due to increase in the interest rates in retail loans

69
 Practical Issues in verification of advances:

❖ Classification and updation of security details in the system – impact on secured and unsecured classification

❖ End- use certificates- not in compliance with the sanction terms or means of utilisation

❖ Disbursement made on the basis of Performa invoice/quotation without obtaining the tax invoice – diversion
of funds

❖ Continuous monitoring of promoter margin vs. margin at the end of the disbursement

❖ Classification of PSL and Non-PSL advances in system- impact & penalty by RBI

❖ Long pending perfection of security by the branch – legal issue vs. procedural matters

❖ Risk of double funding based on copy of Performa invoices/quotations

❖ Non-recognition of penal income in case of non-compliance of sanction terms

70
 Recent RBI development - Ind AS Regime:

❖ RBI directions with respect to banks leading towards Ind AS regime

• Report of RBI working group on Implementation of Ind AS by banks (September 8, 2015)

• Discussion paper on review of Prudential norms for Classification, Valuation and Operations of Investment
Portfolio of Commercial Banks (January 14, 2022)

• Discussion paper on Expected Credit Loss Framework for Provisioning by Banks (January 16, 2023)

❖ Employee benefits – ESOPs accounting as per Black Scholes model (FY 2021-22)

71
THANK YOU
[email protected]