As a part of its supervisory process, the Reserve Bank assesses compliance by banks with extant prudential norms on income recognition, asset classification and provisioning (IRACP). There have been divergences between banks and the supervisor as regards asset classification and provisioning. In order to bring in greater transparency, better discipline with respect to compliance with IRACP norms as well as to involve other stakeholders, the Reserve Bank will mandate disclosures in the notes to accounts to the financial statements of banks where such divergences exceed a specified threshold. Instructions in this regard are being issued separately. – RBI’s Fourth bi-monthly monetary policy statement, 2015-16 dated September 29, 2015.
Background
The Securities and Exchange Board of India (“SEBI”) stipulates numerous disclosure requirements for listed companies. The SEBI (Listing Obligations and Disclosure Requirements) Regulations 2015 (“LODR Regulations”) requires listed entities to disclose all material events or information as soon as it is reasonably possible but not later than twenty-four hours of its occurrence. The SEBI (Prohibition of Insider Trading) Regulations 2015 (“PIT Regulations”) mandates prompt disclosure of unpublished price sensitive information that would impact price discovery no sooner than credible and concrete information comes into being.
RBI vide notification no. RBI/2016-17/283; DBR.BP.BC.No.63/21.04.018/2016-17 dated April 18, 2017, necessitated disclosure by banks in Notes to Accounts in cases of divergence in the asset classification and provisioning. This was to ensure Annual Financial Statements published immediately following communication of such divergence by RBI to the bank were reflective of the position.
SEBI Circular No. CIR/CFD/CMD/80/2017 dated July 18, 2017, titled ‘Disclosure of divergence in the asset classification and provisioning by banks’ extended the application of RBI norms. This circular placed compliance requirements for additional disclosures. It required firstly that the banks must disclose to stock exchanges, divergences in asset classification and provisioning whenever (i) additional provisioning requirements assessed by RBI exceed 10% of the reported profit before provisions and contingencies for the reference period;[1] and/or; (ii) additional gross NPAs identified by RBI exceeded 15% of the published incremental gross NPAs for the reference period. Secondly, it required the disclosures to be made in format prescribed in Annexure therein. Finally, it also required the disclosures to be placed as an Annexure to the Annual financial results filed with the stock exchange in accordance with Regulation 33(3)(d) of the LODR Regulations.
Recent Developments
SEBI vide Circular No. CIR/CFD/CMD1/120/2019 dated October 31, 2019, further bolstered the disclosure requirements for banks with listed securities with respect to divergence and provisioning. It was felt that since these are in nature of material events/information, they necessitate immediate disclosure, which is further prompted by the nature of information being price sensitive.
Thus, disclosures of divergences and provisioning beyond specified threshold need to now be made as soon as possible and not later than 24 hours upon receipt of the Reserve Bank’s Financial Risk Assessment Report rather than waiting to publish the same as part of annual financial statements. The disclosures are to be made in either or both of the above cases.
This comes after recently Pune based Janata Sahakari Bank and Jalgaon Peoples Co-operative Bank were fined INR 1 Crore and INR 25 Lakh respectively for violating income recognition and asset classification norms, management of advances and exposure norms and statutory/other restrictions.[2]
Amusingly, not two days have passed that Lakshmi Vilas Bank, Indian Bank as well as Union Bank have already reported divergence in their bad loans. Per their disclosures to the stock exchanges each, Indian bank reported divergence of INR 820 Crore in its net non-performing assets for 2018-19 while union bank stood at 998.70 crores.[3] Lakshmi Vilas Bank said its NPA divergence was to the tune of INR 54.9 crore in the last fiscal.[4]
Concepts - IRAC Norms
Indian banks did not adhere to uniform accounting practices for income recognition, asset classification and provisioning until 1991. The Narasimham Committee 1991 recommended the establishment of uniform prudential standards based on BASEL Accord and to implement the same in a phased manner. It was the Narasimham Committee’s recommendations that paved the way for RBI norms for treating an asset as non-performing. Though these guidelines were generally welcome, however, the NPA problem was massive already. RBI has on a timely basis issued notifications and instructions to banks with prudential guidelines on income recognition, asset classification and provisioning to meet the demands of the time in this regard.
RBI on July 01, 2015 published the Master Circular on Prudential norms for IRAC and provisioning pertaining to advances vide Circular No. RBI/2015-16/101, DBR.No.BP.BC.2/21.04.048/2015-16 dated July 1, 2015. (“IRAC Norms”).
An asset becomes NP when it ceases to generate income for the bank. The Circular provides that in case of interest payments, banks must 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.
Income recognition
It is objective and based on the record of recovery. Internationally income from NPAs is not recognized on an accrual basis but is booked as income only when it is actually received. Therefore, the banks should not charge and take to income account interest on any NPA. This was eventually amended to extend the application to Government guaranteed accounts also.
Asset classification
After classification of an asset as performing or non-performing. NPAs are needed to be further classified into three categories based on the period for which the asset has remained non-performing and the realisability of the dues.
Substandard assets - A substandard asset would be one, which has remained NPA for a period less than or equal to 12 months. Such 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 that 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.
Loss assets - A loan 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 and recovery value.
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 management 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, provision should be made on NPAs on the basis of classification of assets into prescribed categories above. Taking into account, the time lag between an account becoming doubtful of recover, its recognition as such, the realization 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.
[1] "15 per cent of the published net profits after tax for the reference period" omitted by SEBI Circular No. CIR/CFD/CMD1/ 79 /2019 dated July 17, 2019.
[2] https://www.business-standard.com/article/news-cm/rbi-slaps-fine-on-maharashtra-banks-for-violating-irac-norms-119103000187_1.html
[3] https://economictimes.indiatimes.com/industry/banking/finance/banking/three-banks-report-npa-divergence-a-day-after-sebi-directive/articleshow/71862261.cms
[4] Ibid