Provisioning is a method through which certain lump-sum money is earmarked for write off because now a day’s non-performing assets (NPAs) are one of the leading issues in the banking sector, and higher non-performing assets can worsen the financial health of the bank, so RBI has developed a Provisioning mechanism to tackle non-performing assets or bad assets problems.
The provision means contingency that may be happening or may not occur. For one account, provision for written off has been made by the bank, but if the borrower has paid the entire amount, Provisioning has no meaning as there will not be any written off. Every bank also has to make provision for a standard asset as there is no guarantee of recovery in the case of lending accounts.
Provisioning helps to predict the financial loss towards which the bank is moving by reflecting lousy loan accounts for which recoveries chances are almost negligible. Now a day’s, bank has to do Provisioning from income means profit to fulfill provisioning norms, and this way, banks are reducing the impact of non-performing assets on the bank’s financial health.
RBI has made prudential regulation norms IRAC – Income recognition and Asset Classification for Provisioning in which asset is classified with set provision norms.
IRAC norms
The Reserve Bank of India has introduced the prudential norms for IRAC – Income Recognition, Asset Classification, and Provisioning for the advances portfolio on financial sector reforms based on the Narasimham Committee suggestion in the year 1991 and implemented the same in the year 1993 to promote greater consistency and transparency in the banking sector. Uniform and consistent application of IRAC – Income Recognition, Asset Classification has been introduced to ensure the policy to base on recovery records rather than any subjective considerations.
Income Recognition
Income from non-performing assets (NPA) is to be considered only when the banks and Banks receive it has to reverse the interest felt in the past wrongly. Income recognition with action and Income non-recognition with action are as below.
Income Recognition
(Indian Institute of Banking & Finance)
Income is recognized, if
Interest income of term deposits, Kishan Vikas Patra (KVP), National Savings Certificate (NSC), Indira Vikas Patra (IVP), and Life policies The account on the due date had an adequate margin, which is available.
Interest applicable on Non-performing assets can be taken To provide the credits in the accounts against interest on credit facilities sanctioned with the borrower concerned.
Banks may be continued to quote such accrued interest income. Not realized in a Memorandum account in their books which should not take into account for computing Gross Advances.
Banks may consider income on an accrual basis. In respect of standard assets under implementation
Non-performing asset (NPA) is an income Full provision should be made.
Income Non-Recognition with action
Income is not recognized, in | Action |
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Interest already charged to NPA accounts but not collected | Reverse the interest by debiting the Profit and Loss account. |
Fees, commission, and similar income in respect of past periods | Reverse the interest by debiting the Profit and Loss account. |
Income in respect of substandard assets | Reverse if considered wrongly in past |
Asset Classification
Assets are categorized based on the duration during which the assets were non-performing assets (NPA), and classifications are as mentioned below:
Standard Assets:
An account running as per schedule or ordinary course with timely recovery is known as Standard Assets. These assets do not include additional risk other than the usual business risk.
Sub Standard Assets:
An account remaining in the NPA category for a period, which is not greater than 12 months, is known as Sub Standard Assets.
Doubtful Assets:
An account that remains in the NPA category for more than 12 months or an account remaining in the Sub-Standard Assets category beyond 12 months is known as Doubtful Assets. The account remains in this category until its security value does not fall below 10%, or the bank auditor classifies it in the next category of non-performing assets.
Loss Assets:
The account classified as non-performing assets is treated or subcategorized as loss assets if there is no chance of recovery or the security value has fallen below 10%.
Provisioning should be made based on asset classification, like the duration during which the asset becomes a non-performing asset, availability of security, and releasable value of a security. To fulfill the prudential norms, banks must make provisions on funded outstanding on global loan portfolios based on assets classification, as mentioned below,
Provisioning norms based on Asset Classification
Category | Sector | Provision requirement | |
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Secured Advances | Unsecured Advances | ||
Standard Assets | Agriculture & SMEs | 0.25% of funded outstanding | |
Commercial Real Estate (CRE) | 1.00% of funded Outstanding | ||
Housing Loans at teaser rates | 2% during the teaser rate period and 0.40% after 1 year of rate reset. | ||
Restructured advances Housing loans | For restructured advances, 2% for the first 2 years from the date of restructuring. NPA restructured the account at 2% in the first 5 years from the date of up-gradation. |
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Restructured Accounts | 2% in the first 2 years from the date of restructuring | ||
under moratorium | 2% for the moratorium period and further 2 years (Total 4 years) | ||
Sub Standard Assets | All sectors | 15% of outstanding without making any allowance for ECGC and security available. | Additional 10% in-comparison to secured advances provisioning means total 25% and for infrastructure loans total 20% provided Escrow mechanism is available. |
Doubtful Assets | All sectors | 25% of outstanding for the 1 year, 40% of outstanding for the 2 year and 100% of outstanding for the 3 year onwards. | 100% of outstanding |
Loss Assets | All sectors | 100% of the outstanding |
Provision Coverage Ratio
The degree of provisioning to non-performing assets (NPA) is known as the Provision Coverage Ratio. The Provision Coverage Ratio is the percentage of non-performing asset (NPA) that has to be provided for from the bank’s fund. The Provision Coverage Ratio is different based on the quality of assets as mentioned in IRAC – Income Recognition and Asset Classification norms as the bank has to do the course of action dependent on IRAC benchmarks. The compensation delivered within FY is considered for the Provisioning of development. Thus, the extension in the development plan is directly associated with the bank’s advantage.
Provision against Income
The income generated during Financial Year is considered for the Provisioning of loans to fulfill IRAC norms. Thus, the enhancement in loan provision is directly associated with the bank’s profit. If the Provision Coverage Ratio is 70% for a specific categorized non – performing asset (NPA), banks have to put aside funds equivalent to 70% of those non-performing assets (NPA) out of their profit in most the cases.