Non-Performing Assets – CS Professional Study Material

Chapter 18 Non-Performing Assets – CS Professional Banking Law and Practice Notes is designed strictly as per the latest syllabus and exam pattern.

Non-Performing Assets – CS Professional Banking Law and Practice Study Material

Question 1.
NPA management is the most important responsibility of bankers. Explain how a banker can reduce the probability of an advance turning into NPA. (Dec 2015, 15 marks)
Answer:
The Banker and his ability to assess the customer and the loan requirement go a long way in securing an advance and preventing the same from becoming an NPA. The Banker who lends funds should:
1. Do a proper assessment of the customer. The Banker should have the ability to assess whether the customer can be trusted and will repay the amounts borrowed.

2. He should monitor the advance and the business of customer. The major source of information for monitoring would be the operation of the current or cash credit accounts, the stock and book debts statements submitted by the client and the nature of bills submitted for collection or discount and the inspection of stocks and book debts carried out at regular intervals.

3. The Banker should have the ability to maintain friendly relationship with the customer. The customer should treat the banker as a friend to whom he can confide the ups and downs of business.

4. To check whether the advance requested by the customer is commensurate with his needs.

5. Regular interaction/discussion with the customer is a win-win situation for both. The Banker gets an opportunity to learn about the business of the client and the customer gets benefit of the knowledge of the banker.

The above are general principles for assessment. This has to be followed by a full-fledged assessment of the risks of the customer’s business and how the said advance can be secured with an adequate mix of marketable and less liquid securities and how the bank can be safeguarded against unforeseen circumstances. For this he has to ensure the following:

Marketability of securities.
Taking adequate margins.
Documentation.
The law of limitation.
The realization of the Advance.

Question 2.
Reserve Bank of India issued Guidelines to Indian Commercial Banks on “Timelines for Large Accounts to be referred under IBC, 2016”. Explain. (Dec 2019, 6 marks)
Answer:
In respect of accounts with aggregate exposure of the lenders at ₹ 20 billion and above, on or after March 1, 2018 (‘reference date’), including accounts where resolution may have been initiated under any of the existing schemes as well as accounts classified as restructured standard assets which are currently in respective specified periods (as per the previous guidelines), Resolution Plan (RP) shall be implemented as per the following timelines:

(i) If in default as on the reference date, then 180 days from the reference date.

(ii) If in default after the reference date, then 180 days from the date of the first such default.

(iii) If a RP in respect of such large accounts is not implemented as per the timelines specified in paragraphs, lenders shall file insolvency application, singly or jointly, under the Insolvency and Bankruptcy Code 2016 (IBC) within 15 days from the expiry of the said timeline.

(iv) In respect of such large accounts, where a RP involving restructuring /change in ownership is implemented within the 180-day period, the account should not be in default at any point of time during the ‘specified period’, failing which the lenders shall file an insolvency application, singly or jointly, under the IBC within 15 days from the date of such default.

(v) ‘Specified Period’ means the period from the date of implementation of RP up to the date by which at least 20 percent of the outstanding principal debt as per the RP and interest capitalisation sanctioned as part of the restructuring if any, is repaid.

(vi) Provided that the specified period cannot end before one year from the commencement of the first payment of interest or principal (whichever is later) on the credit facility with longest period of moratorium under the terms of RP.

(vii) Any default in payment after the expiry of the specified period shall be reckoned as a fresh default for the purpose of this framework.

(viii) For other accounts with aggregate exposure of the lenders below ₹ 20 billion and, at or above ₹ 1 billion, the Reserve Bank intends to announce, over a two-year period, reference dates for implementing the RP to ensure calibrated, time-bound resolution of all such accounts in default.

(ix) It is, however, clarified that the said transition arrangement shall not be available for borrower entities in respect of which specific instructions have already been issued by the Reserve Bank to the banks for reference under IBC. Lenders shall continue to pursue such cases as per the earlier instructions.

Question 3.
Explain the following statement in brief on the point of reasoning :
Bank is giving emphasis on reduction on Non-performing Assets. (Dec 2021, 1 marks)
Answer:

To improve the Interest Income of the Bank as interest on Non-performing Assets (NPAs) cannot be booked as income.
To reduce the burden of making provisions out of profits earned by the Banks.
To recycle the funds blocked in Non-performing Assets. (NPA)
An effort in meeting the RBI requirement i.e., Provisions and Capital Adequacy Ratio in respect of NPAs.

Question 4.
What is the purpose of provisioning in Banks ? What is Provisioning Coverage Ratio (PCR)? (Dec 2021, 3 marks)
Answer:
One of the leading issues related with the banking sector nowadays is the rising level of NPAs. Higher NPAs worsens the financial health of a bank. To tackle the NPA or bad assets problem, RBI has designed several mechanisms. An import one among them is the Provisioning norms. Provisioning is a part of the RBI’s prudential regulation norm.

Under provisioning, banks have to set aside or provide funds to a prescribed percentage of their bad assets. The percentage of bad asset that has to be provided for is called Provisioning Coverage Ratio (PCR). The provisioning coverage ratio is the percentage of bad assets that the bank has to provide for (keep money) from their own funds-most probably profit. It can also be defined as:

PCR = \(\frac{\text { TotalProvisions }}{\text { GrossNPAs }}\)
e.g., if the provisioning coverage ratio is 70% for a particular category of bad loans, banks have to set aside funds equivalent to 70% those bad assets out of their profits (in most cases).

Assets of a bank means loans they have given and investment they have made. If the loans are not coming, there should be provisioning for such bad debts. The assets are classified by the RBI in terms of their duration of non-repayment.

Provisioning differs with asset quality:
Provisioning coverage ratio differs in terms of the quality of assets. Some assets may be lost forever and they are categorized as loss assets. This implies that such loans will never be repaid. For such assets, bank has to set aside 100% of such loss assets out of-its profit. Similarly, there may be substandard assets where the loans are not repaid for a shorter period. In this case, less proportion of those assets can be set aside from profit as per RBI directives.

Now-a-days due to Provisioning requirement, when banks report profits, they pay low dividends. Many banks have substantial NPAs now and they are setting apart a major chunk of their profit to meet the provisioning.

Question 5.
Non-Performing Assets (NPAs) have made the banks financially ill. Comment. (June 2022, 4 marks)

Question 6.
While closing its books of account on 31^st March, 2018, a branch of commercial bank finds that: (June 2018)
(i) On a Term Loan of ₹ one lakh fifty thousand, quarterly interest due on 29th September, 2017, 29^th December, 2017 and 29^th March, 2018 has not been received and served. (2 marks)
(ii) The outstanding balance of an overdraft account has been continuously in excess of the sanctioned limit of ₹ one lakh since 14^th May, 2017 till 31.3.2018. (2 marks)
(iii) ₹ 75,000, the amount of discounted bill was due on 17^th February, 2018 but the same has not been received and the bill was dishonoured. (1 mark)
Explain with reasons which of the above mentioned credit facilities will be treated as NPA on 31^st March, 2018.
Answer:
(i) According to the guidelines of the Reserve Bank of India, a term loan is to be treated as a Non – Performing Asset (NPA) if interest and / or instalment of principal remains overdue for a period of more than 90 days. In the given case, interest due on 29^th March, 2018, has not become overdue for a period of more than 90 days but interest due on 29^th December, 2017 and interest due on 29th September, 2017 have become overdue for periods of more than 90 days. Hence, the term loan is to be treated as NPA on 31^st March, 2018.

(ii) As per the guidelines of the Reserve Bank of India, an overdraft account is treated as NPA if it remains out of order for a period of more than 90 days. One of the ways, an overdraft account may become out of order is that it remains continuously in excess of the sanctioned limit. In the instant case, the overdraft account has been out of order for more than 90 days. Hence, it is to be treated as NPA.

(iii) As per the relevant guidelines of the Reserve Bank of India, bills purchased and discounted are treated as NPA if they, remain overdue and unpaid for a period of more than 90 days. In the present case, the discounted bill has not yet remained overdue for more than 90 days, Hence, it is not to be treated as NPA.

Question 7.
ABC bank has financed a term loan of ₹ 120 lakh to a Micro Small Enterprises unit, which was repayable in 60 monthly instalments of ₹ 2.00 lakh and Interest.

The monthly instalments of ₹ 2.00 lakh plus interest from 15^th December, 2017 remained unpaid though the available security is more than the outstanding balance (₹ 80 lakhs).

Explain the movement of Asset Classification of account and provision requirement (percentage and amount) as per RBI guidelines. (Dec 2019, 6 marks)
Answer:
The instalments remained overdue from 15^th December, 2017. Balance outstanding is ₹ 80 lakh as on the date of NPA. Outstanding is 100% secured by the asset charged to the bank. On the basis of record of recovery, the asset classification will be as under:

Period	Asset Classification	Provision Norms as per RBI guidelines	Provision Requirement
A	B	C	D
15^th December, 2017 to 14^th March, 2018	Standard (SMA-0, SMA-1, SMA-2)	0.25%	₹ 20,000
15^th March, 2018 to 14^th March, 2019	Sub Standard	15%	₹ 12 lakh
15^th March, 2019 to 14^th March, 2020	Doubtful – Category – I	25%	₹ 20 lakh
15^th March, 2020 to 14^th March, 2022	Doubtful – Category – II	40%	₹ 32 lakh
15^th March, 2022 onwards	Doubtful – Category – III	100%	₹ 80 lakh

Question 8.
Case Study:
Smart Agro Foods Ltd. is a listed entity at BSE and NSE. It started its operations since September, 2015. The Company is engaged in the business of trading of agriculture commodities. It was enjoying a working capital cash credit limit of ₹ 100 lakh and from West Bank Ltd. (Aug 2021)

In the month of January, 2017, the company decided to expand its business activity and to undertake the manufacturing and processing of agro commodities. The expansion plan included manufacturing of tomato catch-up, bakery biscuits & cakes and packaged sweets of Rasgulla & Gulabjamun. For this ambitious expansion plan the company came out with IPO in June, 2017 to raise the money for purchase of land and erection of factory site at Telangana, Jodhpur and Bikaner. The issue was successfully completed and the company purchased the land and erected the factory buildings at the above three places.

To meet out the cost of plant and working capital at these places the company availed consortium loans from three banks, including the present banker. The various credit facilities sanctioned by the consortium of three banks in April, 2019 were as under: (₹ in Lakh.)

Credit Facility	West Bank Ltd.	Jodhpur Bank Ltd.	Bikaner Bank Ltd.	Total
Cash Credit (existing)	100	—	—	100
New Cash Credit Limit	75 (For Tomato Catch-up Division)	50 (For Bakery and Cake Division)	50 (For Sweets Division)	175
Term Loan (For Purchasing of Automatic Plant for Manufacturing)	40 (For Tamoto Catch-up Division)	25 (For Bakery and Cake Division)	30 (For Sweets Division)	95
Total	215	75	80	370

The company has offered the following securities for its cash and term loan to the bankers: (₹ in Lakh)

Security	West Bank Ltd.	Jodhpur Bank Ltd.	Bikaner Bank Ltd.
Hypothecation of Book Debts	200#	60#	65#
Hypothecation of Plant & Machinery	40	50 + 25 = 75	50 + 30 = 80
Value of Land and Building	1200 (At Telangana Industrial Area where Tomato Ketch-up is manufactured)	1500 (At Jodhpur Industrial Area where Baker and cakes are manufactured)	1000 (At Bikaner Industrial Area where Sweets are manufactured)
# It represents the average of the book debts during the FY 2019-20.

The company’s performance during the FY 2019-20 was satisfactory. However, with the beginning of the FY 2020-21 the manufacturing activity got slow down due to nationwide closure on account of COVID-19 and migration of the workers. On account of this the company was not able to pay the instalments of the term loans to all the three bankers as well as the transactions in the cash credit account were also stopped and the company was not able to service the interest charged in the cash credit account. As a result, the accounts were classified by the bankers as Non-performing accounts (NPA).

The West Bank Ltd. is the Consortium Leader. By the end of the June, 2020 quarter the accounts of the company were showing problems. From July, 2020 to Sept., 2020 the company could not deposit the EMI of term loan, no stock statements were submitted in cash credit accounts and no interest on outstanding amount of cash credit could be deposited. The accounts were classified as Sub-standard in the books of all the banks.

The bankers insisted for recovery of the dues. The company pleaded that security pledged/hypothecated/mortgaged with the bankers is much more than the amount outstanding in the various loan accounts. The bankers did not accept the plea, continuously pressurized the company to pay the dues of the bankers else will take legal recourses available under various lows such as, Recovery of Debts and Bankruptcy Act, 1993, Insolvency and Bankruptcy Code, 2016 (IBC) and Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI).

Based on the above facts, answer the following questions:
(a) Explain the meaning of Non-Performing Accounts (NPA). When banks can classify the Term loans and Cash credit accounts as Non-Performing Accounts (NPA)? (8 marks)

(b) In the above question, the bankers have classified the accounts as Sub-standard. Explain the classification of NPAs. What is meant by re-structuring of Bank Loans? . (6+2 marks)

(c) If in the above case, the company is able to pay the EMI of term loan and maintain transactions, pay interest and submit stock statements in the account with West Bank Ltd. only and for other two banks, it could not pay the EMI and interest:
(i) In such a situation, whether the West Bank Ltd. should classify the accounts as NPA since other bankers have classified the account as NPA?
(ii) What would be your answer, if only term loan EMI with West Bank Ltd. are paid by the company and the Cash Credit accounts remains irregular. Whether in that case only the CC accounts be classified as NPA or whole of the credit facility should be classified as NPA?
(iii) The company pleaded that the Security tendered to the banks amounts to much higher than of the outstanding in the loans accounts. (2 + 3 + 3 marks)

(d) How the NPA is to be recognised in:

Cash Credit account and
Term Loans Account? (4 + 4 marks)

(e) If any loan or advances is classified as NPA, what provisions have to made by the bankers in their books and how to treat such provisions? (8 marks)
Answer:
(a) 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:

Interest and /or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan.
The account remains ‘out of order’ in respect of an Overdraft / Cash Credit for more than 90 days. Regular / ad hoc limits not been renewed within 180 days from the due date / date of ad hoc sanction.
The bill remains overdue for a period of more than 90 days in the case of bills purchased and discounted.
The instalment of principal or interest thereon remains overdue for two crop seasons for short duration crops (maturing within one year).
The instalment of principal or interest thereon remains overdue for one crop season for long duration crops (maturing after one year) (other agriculture loans 90 days norms are applicable).
The amount of liquidity facility remains outstanding for more than 90 days, in respect of a securitization transaction undertaken in terms of guidelines on securitisation dated 1st February, 2006.
In respect of derivative transactions, the overdue receivables representing positive mark-to-market value of a derivative contract, if these remain unpaid for a period of 90 days from the specified due date for payment.
If minimum amount due, indicated in monthly Credit Card Statement is not paid fully within 90 days from the due date of the bill.
Loans guaranteed by State Goverment the normal rules are applicable. Where guaranteed by Central Goverment loans will continued to be standard category and no provision shall be made.

In case of interest payments, banks should, classify an account as NPA only if the interest due and charged during any quarter is not serviced fully within 90 days from the end of the quarter.

Accounts with temporary deficiencies
In addition, an account may also be classified as NPA Accounts with temporary deficiencies. The classification of an asset as NPA should be based on the record of recovery. Bank should not classify an advance account as NPA merely due to the existence of some deficiencies which are temporary in nature such as non-availability of adequate drawing power based on the latest available stock statement, balance outstanding exceeding the limit temporarily, non-submission of stock statements and non-renewal of the limits on the due date, etc. In the matter of classification of accounts with such deficiencies banks may follow the following guidelines:

i) Banks should ensure that drawings in the working capital accounts are covered by the adequacy .of current assets, since current assets are first appropriated in times of distress. Drawing power is required to be arrived at based on the stock statement which is current. However, considering the difficulties of large borrowers, stock statements relied upon by the banks for determining drawing power should not be older than three months. The outstanding in the account based on drawing power calculated from stock statements older than three months, would be deemed as irregular.

A working capital borrowal account will become NPA if such irregular drawings are permitted in the account for a continuous period of 90 days even though the unit may be working or the borrower’s financial position is satisfactory.

ii) Regular and ad hoc credit limits need to be reviewed / regularised not later than three months from the due date / date of ad hoc sanction. In case of constraints such as non-availability of financial statements and other data from the borrowers, the branch should furnish evidence to show that renewal /review of credit limits is already on and would be completed soon. In any case, delay beyond six months is not considered desirable as a general discipline. Hence, an account where the regular /ad hoc credit limits have not been reviewed / renewed within 180 days from the due date/date of ad hoc sanction will be treated as NPA.

Advances against Term Deposits, Kisan Vikas Patras, National Savings Certificate and insurance policies need not be treated as NPAs as long as adequate margin is available in the account. Advances against gold and other securities are not covered under this exemption.

(b) Classification of NPAs
Banks are required to classify non-performing assets further into the following three categories based on the period for which the asset has remained non- performing and the realisability of the dues:

Substandard Assets.
Doubtful Assets.
Loss Assets.

Standard asset is one which does not show any problems and does not carry more than normal business risk.

Substandard Assets
A substandard asset would be one, which has remained NPA for a period less than or equal to 12 months. Such an asset will have well defined credit weaknesses that jeopardize the liquidation of the debt and are characterized by the distinct possibility that the banks will sustain some loss, if deficiencies are not corrected.

Doubtful Assets
An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months. A loan classified as doubtful has all the weaknesses inherent in assets that were classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values- highly questionable and improbable. Three sub-categories are as under:

Doubtful up to one year;
Above one up to three years; and
Above three years.

Loss Assets
A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.

Restructuring
When a lender gives concession to the borrower, for economic or legal reasons relating to the borrower’s financial difficulty it is called Restructuring. It normally involves:

Modification of terms of the Advances / Securities, including alteration of repayment period /repayable amount / the amount of instalments /rate of interest.

Sanction of additional credit facility.
Roll over of credit facility.
Enhancement of existing Credit Limit.
Compromise Settlement.

Banks may restructure standard, sub-standard and doubtful category accounts. Standard assets are to be classified as sub-standard assets on restructuring. NPAs upon restructuring continue to be in the same asset classification.

(c) (i) Advances under consortium arrangements
Yes. West Bank would classify the asset as Standard whereas the other two banks would classify them as NPAs on account on the following grounds:

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. Where the remittances by the borrower under consortium lending arrangements are pooled with one bank and / or where the bank receiving remittances is not parting with the share of other member banks, the account will be treated as not serviced in the books of the other member banks and therefore, be treated as NPA.

The banks participating in the consortium should, therefore, arrange to get their share of recovery transferred from the lead bank or get an express consent from the lead bank for the transfer of their share of recovery, to ensure proper asset classification in their respective books.

(ii) Asset Classification to be borrower-wise and not facility-wise
Even if term loan account is regular but other accounts of the borrower are irregular then entire advances of the borrower will be treated as NPA on account of the following RBI guideline:

All the facilities granted by a bank to a borrower will have to be treated as NPA and not the particular facility/investment or part thereof which has become irregular (except loans against deposit, insurance policies NSCs).

(iii) Security Cover is more than outstanding loans
The pleadings of the borrower will not be taken in to account as, the RBI has advised that the availability of security or net worth of borrower /guarantor should not be taken into account for the purpose of treating an advance as NPA or otherwise.

(d) (i) NPA in Cash Credit account
The Cash Credit account shall be classified as NPA if it remains ‘out of order’.

Out of Order status : An account should be treated as ‘out of order’, if the outstanding balance remains continuously in excess of the sanctioned limit / drawing power for 90 days. In cases where the outstanding balance in the principal operating account is less than the sanctioned limit / drawing power, but 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, these accounts should be treated as ‘out of order’.

Overdue : 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.

(ii) NPA in Term Loan
The Term Loan account shall be classified as NPA if the interest and /or instalment of principal remain overdue for a period of more than 90 days in respect of a term loan.

(e) Provisioning Norms
The primary responsibility for making adequate provisions for any diminution in the value of loan assets, investment or other assets is that of the bank managements and the statutory auditors. The assessment made by the inspecting officer of the RBI is furnished to the bank to assist the bank management and the statutory auditors in taking a decision in regard to making adequate and necessary provisions in terms of prudential guidelines.

In conformity with the prudential norms, provisions should be made on the nonperforming assets on the basis of classification of assets into prescribed categories. Taking into account the time lag between an account becoming doubtful of recovery, its recognition as such, the realisation of the security and the erosion over time in the value of security charged to the bank, the banks should make provision against substandard assets, doubtful assets and loss assets as below:

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

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.
In regard to the secured portion, provision may be made on the following basis, at the rates ranging from 25 percent to 1.00 percent of the secured portion depending upon the period for which the asset has remained doubtful:

Period for which the advance has remained in ‘doubtful category	Provision requirement (%)
Up to one year	25
One to three years	40
More than three years	100

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 ₹ 5 crore and above stock audit at annual intervals by external agencies appointed as per the guidelines approved by the Board would be mandatory in order to enhance the reliability on stock valuation. Collaterals such as immovable properties charged in favour of the bank should be got valued once in three years by valuers appointed as per the guidelines approved by the Board of Directors.

Substandard Assets
A general provision of 15 percent on total outstanding should be made. Sub-standard (unsecured) 25%, sub-standard unsecured (infrastructure) 20%.

In addition to the above the banks are also required to maintain provisions on standard assets, details of which are as under:

Standard Assets
The provisioning requirements for all types of standard assets stands as below.

Banks should make general provision for standard assets at the following rates for the funded outstanding on global loan portfolio basis:

Farm Credit to agricultural activities and Small and Micro Enterprises (SMEs) sectors at 0.25 per cent;
Advances to Commercial Real Estate (CRE) Sector at 1.00 per cent;
Advances to Commercial Real Estate – Residential Housing Sector (CRE – RH) at 0.75 percent;
Housing loans extended at teaser rates, provisioning will be 2.00 percent in view of the higher risk associated with them. 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’. On restructured advances it will be 5%;
All other loans and advances not included in (a) (b) and (c) above at 0.40 percent.

Non-Performing Assets – CS Professional Banking Law and Practice Study Material

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