IRAC Norms and NPA Classification
When a loan stops performing, which bucket it falls into, and how much the bank sets aside. Here are the rules, worked.
IRAC stands for Income Recognition, Asset Classification and Provisioning. These are RBI's rules for deciding when a loan has stopped performing, which bucket it falls into, and how much money the bank must set aside against it. The base rule: an asset becomes non-performing when it stops generating income for the bank.
Banks cannot book interest on an NPA as income, even if the account is government guaranteed. So the date an account turns NPA hits the bank's profit directly, which is why the CCP paper tests the cut-offs so precisely.
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When a Loan Becomes an NPA
| Facility | NPA when |
|---|---|
| Term loan | Interest or principal instalment overdue for more than 90 days |
| Cash credit or overdraft | The account stays 'out of order' (see below) |
| Bills purchased or discounted | The bill is overdue for more than 90 days |
| Short-duration crop loan | Instalment overdue for two crop seasons |
| Long-duration crop loan | Instalment overdue for one crop season |
| Credit card | Minimum amount due not paid in full within 90 days of the payment due date |
'Out of Order' for Cash Credit and Overdraft
- check_circleThe balance stays above the sanctioned limit or drawing power continuously for 90 days, or
- check_circleThe balance is within the limit but there are no credits continuously for 90 days, or
- check_circleThe balance is within the limit but credits over the previous 90 days do not cover the interest debited.
- check_circleDrawings against a stock statement older than three months are irregular; 90 days of such drawings make the account an NPA.
- check_circleLimits not reviewed or renewed within 180 days of the due date also make the account an NPA.
Special Mention Accounts (SMA): Stress Before NPA
Banks must tag stress immediately on default, before the account turns NPA.
SMA-0
Term loans: amount overdue for
Up to 30 days
Cash credit / OD: over limit or DP (lower) for
Not used
SMA-1
Term loans: amount overdue for
More than 30 and up to 60 days
Cash credit / OD: over limit or DP (lower) for
More than 30 and up to 60 days
SMA-2
Term loans: amount overdue for
More than 60 and up to 90 days
Cash credit / OD: over limit or DP (lower) for
More than 60 and up to 90 days
| Tag | Term loans: amount overdue for | Cash credit / OD: over limit or DP (lower) for |
|---|---|---|
| SMA-0 | Up to 30 days | Not used |
| SMA-1 | More than 30 and up to 60 days | More than 30 and up to 60 days |
| SMA-2 | More than 60 and up to 90 days | More than 60 and up to 90 days |
RBI's Own Dating Example
Tags are applied in the bank's day-end process, and the tag date is that calendar date.
| Event | Date |
|---|---|
| Instalment due and not paid | 31 March 2022 (overdue from this date) |
| 30 days continuously overdue: SMA-1 | 30 April 2022 |
| 60 days continuously overdue: SMA-2 | 30 May 2022 |
| Over 90 days: NPA | 29 June 2022 |
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Asset Classes and Provisioning
Standard
Definition
Performing
Provision
0.40% for most loans; 0.25% for farm credit, individual housing and small and micro enterprises; 1% for commercial real estate; 0.75% for CRE residential housing
Substandard
Definition
NPA for up to 12 months
Provision
15% of the total outstanding (no allowance for ECGC cover or security); 25% if the exposure is unsecured
Doubtful, up to 1 year
Definition
In substandard for 12 months, then doubtful for up to 1 year
Provision
100% of the unsecured part + 25% of the secured part
Doubtful, 1 to 3 years
Definition
Doubtful for 1 to 3 years
Provision
100% of the unsecured part + 40% of the secured part
Doubtful, over 3 years
Definition
Doubtful for more than 3 years
Provision
100%
Loss
Definition
Loss identified but not written off
Provision
Write off, or provide 100%
| Class | Definition | Provision |
|---|---|---|
| Standard | Performing | 0.40% for most loans; 0.25% for farm credit, individual housing and small and micro enterprises; 1% for commercial real estate; 0.75% for CRE residential housing |
| Substandard | NPA for up to 12 months | 15% of the total outstanding (no allowance for ECGC cover or security); 25% if the exposure is unsecured |
| Doubtful, up to 1 year | In substandard for 12 months, then doubtful for up to 1 year | 100% of the unsecured part + 25% of the secured part |
| Doubtful, 1 to 3 years | Doubtful for 1 to 3 years | 100% of the unsecured part + 40% of the secured part |
| Doubtful, over 3 years | Doubtful for more than 3 years | 100% |
| Loss | Loss identified but not written off | Write off, or provide 100% |
What Counts as 'Unsecured'
An exposure is unsecured if the realisable value of the security is not more than 10% of the outstanding exposure from the start. Security means tangible security properly charged to the bank. Guarantees, including state government guarantees, and comfort letters do not count. Unsecured doubtful assets need 100% provision.
Worked Case 1: Substandard
Secured term loan, NPA for 7 months
Outstanding
₹20 lakh
Rate
15%
Provision
₹3 lakh
Unsecured loan, NPA for 7 months
Outstanding
₹20 lakh
Rate
25%
Provision
₹5 lakh
| Account | Outstanding | Rate | Provision |
|---|---|---|---|
| Secured term loan, NPA for 7 months | ₹20 lakh | 15% | ₹3 lakh |
| Unsecured loan, NPA for 7 months | ₹20 lakh | 25% | ₹5 lakh |
Worked Case 2: Doubtful for Two Years
Outstanding ₹10 lakh. Realisable value of security ₹6 lakh.
Unsecured part (10 − 6)
Amount
₹4 lakh
Rate
100%
Provision
₹4 lakh
Secured part
Amount
₹6 lakh
Rate
40%
Provision
₹2.4 lakh
Total provision
Amount
Rate
Provision
₹6.4 lakh
| Part | Amount | Rate | Provision |
|---|---|---|---|
| Unsecured part (10 − 6) | ₹4 lakh | 100% | ₹4 lakh |
| Secured part | ₹6 lakh | 40% | ₹2.4 lakh |
| Total provision | ₹6.4 lakh |
Worked Case 3: RBI's ECGC Example
From the IRAC master circular. Outstanding ₹4 lakh, ECGC cover 50%, doubtful for more than 2 years, security ₹1.5 lakh.
| Step | Amount |
|---|---|
| Outstanding balance | ₹4.00 lakh |
| Less: value of security | ₹1.50 lakh |
| Unrealised balance | ₹2.50 lakh |
| Less: ECGC cover (50% of unrealised balance) | ₹1.25 lakh |
| Net unsecured balance | ₹1.25 lakh |
| Provision on unsecured part at 100% | ₹1.25 lakh |
| Provision on secured part (₹1.5 lakh) at 40% | ₹0.60 lakh |
| Total provision | ₹1.85 lakh |
Rules That Decide Many Questions
- check_circleClassification is borrower-wise, not facility-wise. If one facility turns NPA, all facilities of that borrower are NPA.
- check_circleSecurity or the borrower's net worth does not stop an account from becoming NPA.
- check_circleIf the realisable value of security falls below 50% of the value assessed earlier, the NPA can go straight to doubtful. Below 10% of the outstanding, it goes straight to loss.
- check_circleAn NPA is upgraded to standard only when the entire arrears of interest and principal are paid, across all the borrower's facilities.
- check_circleA few credits just before the balance sheet date do not cure an account with inherent weakness.
- check_circleNPAs with balances of ₹5 crore and above need an annual stock audit by an external agency; immovable collateral must be revalued once in three years.
FAQs
When does a loan become an NPA?expand_more
When interest or principal stays overdue for more than 90 days for a term loan, or a cash credit account stays out of order for 90 days. Crop loans follow crop seasons instead.
What are SMA-0, SMA-1 and SMA-2?expand_more
Early stress tags: overdue up to 30 days (SMA-0), more than 30 and up to 60 days (SMA-1), and more than 60 and up to 90 days (SMA-2). Beyond 90 days the account is an NPA.
What is the provision for a substandard asset?expand_more
15% of the total outstanding, or 25% if the exposure is unsecured. Infrastructure loans with escrow safeguards can be provided at 20%.
When does a substandard asset become doubtful?expand_more
After it has stayed in the substandard category for 12 months. It can go straight to doubtful earlier if the security's value erodes below 50% of its assessed value.
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