Pillai Institute of Management Studies and

Research (PIMSR),
New Panvel

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 Master of Management Studies (MMS)
Semester - IV
Subject (Finance - Elective) :
Commercial Banking

Lesson-12: IRAC Norms and NPA Management

Lecture date :

by
Prof. K.G.S. MANI

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Lecture date :
Lesson- 12 : IRAC Norms and NPA Management
(1) Definitions (concepts) :
(i) IRAC means Income Recognition and Assets Classifications and
NPA means Non-Performing Assets in the bank’s books.

(ii) Out of Order Account :

An account should be treated as ‘out of order’ if the
outstanding balance remains continuously in excess of the
sanctioned limit/drawing power. In cases where the outstanding
balance in the principal operating account is less than the
sanctioned limit/drawing power, but there are no credits in the
account, continuously for 90 days or credits are not enough to
cover the interest debited during the same period, these
account should be treated ‘out of order’ accounts.

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(iii) Overdue :
Any amount due to the bank under any credit facility is called
‘overdue’ , if it not paid on the due date fixed by the bank.

(iv) Wilful Default :

As per RBI guidelines a “wilful default” is deemed to have
occurred if any of the following event is noted or observed :
(a) Default in repayment obligations by the unit to the lender
(bank) even when it has the capacity to honour the said
obligations. (example: Kingfisher Airlines)
(b) Default in repayment obligations by the unit to the lender and
has not utilised the finance from the lender for the specific
purposes for which finance was availed of but has diverted the
funds for other purposes. (examples : diversion of funds from
short term source to long term, diverting the funds to associate
companies, sister concerns, etc)

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(c) Default in repayment obligations by the unit to the lender (bank)
and has siphoned-off the funds so that the funds have not been
utilised for the specific purpose for which finance was availed of,
nor are the funds available with the unit in the form of other
assets.
(d) Default in repayment of obligations by the unit to the lender
and has also disposed off or removed the movable fixed assets
or immovable property given by it for the purpose of securing a
term loan without the knowledge of the bank / lender.
(e) Default to be categorised as ‘wilful’ must be intentional,
deliberate and calculated. Wilful Defaulter can be individual,
firm, company or any other type of business entity.
----------------------------------------------------------------------------------
Note: RBI guidelines state that where more than one credit facility
is sanctioned to the borrower and any one account becoming
NPA, all other accounts should also be classified as NPA in the
books of the Bank.(example)

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(v) Diversion and siphoning of funds :
Diversion of funds referred to above would include the following:
(a) Utilisation of short term working capital funds for long term
purposes not in conformity with the terms of sanction.
(b) Deploying borrowed funds for purposes / activities or creation
of assets other than those for which the loan was sanctioned.
(c) Transferring funds to the subsidiaries / group companies or
other corporate by whatever modalities.
(d) Routing of funds through any bank other than the lender bank
or members of consortium without prior permission of the
lender.
(e) Investment in other companies by way of acquiring equities /
debt instruments without approval of lenders.
(f) Shortfall in deployment of funds vis-à-vis the amounts disbursed
/ drawn and the difference not being accounting for.

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(g) Siphoning of funds is said to occur if any funds borrowed from
banks / FIs are utilised for purpose un-related to the operations
of the borrower, to the detriment of the financial health of the
entity or of the lender.
(h) Identification of ‘wilful default’ should be made considering the
track record of borrowers and should not be decided on the
basis of isolated transactions/incidents.

(vi) Special Mention Accounts (SMA):

RBI introduced the concept of SMAs to revitalise the borrowing
accounts turning into NPAs. Key points of RBI are as mentioned
below :
SMA sub-categories Basis of classification
(a) SMA-0 : Principal or interest payment not overdue
for more than 30 days but account showing
signs of incipient stress (points are below).

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 SMA sub-categories Basis of classification
(b) SMA-1 : Principal or interest payment overdue
between
31 – 60 days.
(c ) SMA-2 : Principal or interest payment overdue
between 61 – 90 days.

(vii) Signs of stress for categorising an account as SMA-0 :

(a) Delay in submission of stock statement, select data and
financial statements for renewal of credit facilities.
(b) Actual sales / operating profit falling short by 40% of
projections.
(c) Borrower not co-operating for stock audit.
(d) Reduction of Drawing Power by 20% or more after stock audit.
(e) Concrete evidence of diversion of funds

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(f) Drop in internal risk rating by 2 or more notches in a single
review at a time.
(g) Return of 3 or more cheques issued by borrower in 30 days.
(h) Return of 3 or more bills discounted by the bank, or sent for
collection.
(i) Devolvement of Deferred Payment Guarantee instalment(s) or
Letter of Credit or Invocation of Bank Guarantee and its non-
payment within 30 days.
(j) Increase in frequency of overdrafts in current accounts.
(k) Borrower reporting stress in the business and financials.
(l) Promoter(s) pledging / selling their shares in the borrower
company due to financial stress.
(m) Non-compliance with any of the terms and conditions of
sanction of loans and advances.

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(2) Causes of Non-Performing Assets (NPAs) :
There are various reasons for the loans and advances to
become Non-Performing Assets (NPAs). Broadly, they are
classified in internal causes and external causes.
The internal causes are those which are within the control of
the borrower because they may arise due to the internal
management or problems in production, marketing, finance and
administrative aspects of the company/business. Some of them
are mentioned below:
(a) Production:
(i) Lack of proper planning and control;
(ii) Inappropriate or outdated technology;
(iii) Unsatisfactory performance of machines, frequent break down;
(iv) Faulty inventory planning;
(v) Poor labour productivity;
(vi) Poor quality control.

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(b) Marketing:
(i) Unrealistic estimates of demand for the product;
(ii) Inappropriate product mix;
(iii) Poor efforts for sales promotion;
(iv) Non-adherence to delivery schedules;
(v) Improper costing and pricing system;
(vi) Lack of distribution channels.

(c) Finance:
(i) Faulty costing and pricing;
(ii) Increased cost of production;
(iii) Diversion of funds for unproductive expenses;
(iv) Inadequate working capital finance;
(v) Costly borrowings from outside source.

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(d) Administration :
(i) Lack of managerial skills, trained manpower, etc.
(ii) Lack of co-ordination among various departments;
(iii) Lack of proper organisation set up;
(iv) Poor industrial relations;
(v) Dispute among partners or Directors;
(vi) Dishonesty among partners or Directors;
(vii) Wilful Default.

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(3) Classification of Assets:
(i) Standard Assets (SA): In this accounts (loans and
advances) (SAs), all the instalments and interest are paid
regularly by the borrowers and there is no symptom of any
default by the borrowers. Standard Assets are those loans and
advances which are not Non-performing Assets. In other
words, these are regular and performing and there are no
adverse features. They do not disclose any credit problems and
it carries normal risk.
(ii) Sub-standard Assets (SSA): Sub-standard Assets are those
assets (loans and advances) in which instalment and interest
are not paid for a period of 12 months. If the account (loans
and advances) remains non-performing asset for a period of 12
months, it is classified as sub-standard assets (SSA). In such
cases, the current net worth of the borrower/guarantor or the
current market value of the security charged is not enough to
ensure the recovery of the dues to the bank in full.

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(iii) Doubtful Assets:
A Doubtful Asset (DA) (Doubtful Loans and Advances) is one
which remains NPA for a period exceeding one year from the
date of its becoming NPA. It means all sub-standard accounts
will be automatically classified as doubtful assets after the
expiry of one year from the date of its classification as sub-
standard assets (SSA). Those accounts classified as Doubtful
Assets have all inherent weakness of Sub-Standard Assets.
These DAs show erosion of value in the security and recovery
of loan amounts are bleak. All Doubtful Assets are to be
further classified into three categories as under :
(a) Doubtful Assets (Loans and advances) upto 1 year;
(b) Doubtful Assets for more than 1 year but upto 3 years;
(c) Doubtful Assets for more than 3 years.
An assets remaining Doubtful Assets for more than 3 years (i.e.
NPA for more than 4 years) will be continued to be classified

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 as ‘Doubtful Assets’ till such time, there are some tangible
securities available and chances of recovery of bank’s dues from
various securities/sources are still existing.

(iv) Loss Assets :

All Doubtful Assets where the chances of realisation of bank’s
dues from all the available sources are negligible or NIL and the
bank does not hold any tangible security with realisable value,
such Doubtful Assets will be treated as Loss Assets. Moreover,
if the documents are not enforceable, an asset (DA) should also
be treated as Loss Assets. Such an asset (DA) 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. In short, the Doubtful Assets
fulfilling the following conditions can be classified as ‘Loss
Asset’.

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(a) The documents for loans and advances are not enforceable in
the court of law.
(b) The documents are enforceable in the court, but there is no
value for the security held by the bank. (the value of security is
NIL).
(c) Net worth of the borrower/guarantor is negligible or NIL.
(d) No guarantee cover (Credit Guarantee Corporation’s Guarantee
cover) is available.

A loss asset is one where loss has been identified by the bank
or internal or external auditors or RBI inspection (audit), but the
amount has not been written off wholly. Considered
uncollectible and ideally such loans should be written off out of
profit during the year.

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(4) Classification of Accounts as NPA:
For the purpose of classifying an account as Non-Performing
Asset, advances are classified in four broad categories as
mentioned below:
(i) Term Loans:
This includes Term Loans, Demand Loans, Working Capital
Term Loan, Personal Loans, Loans against Bank’s own
deposits, Loans against Govt. securities/shares, etc, Bridge
Loans, Crop Loan and all Staff Loans.
(ii) Cash Credit/Overdrafts:
This includes Cash Credit, Packing Credit, Overdraft against
Fixed Deposits or Recurring Deposits, Govt. Securities or
Shares, Advance against Trust Receipts, etc.
(iii) Bills Purchased/Bills Discounted:
This includes Bills (both demand and usance bills, cheques,
purchased and discounted. Foreign Bills Purchased/Discounted
and Bills returned unpaid by the drawee.
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(iv) Other Accounts:
This includes other credit facilities not mentioned above, i.e.
Advance Bills, Guarantees, and Deferred Payment Guarantees
invoked, Duty Drawback and Temporary Overdrafts.

(5) Identification of Non-Performing Assets:

As per Reserve Bank of India guidelines under ‘Income
Recognition and Assets Classification’ (known as IRAC) norms,
Assets (Loans and Advances) should be identified and classified
as Non-Performing Assets (NPAs) as per following guidelines:
(i) Term Loan :
If the interest and/or instalment of principal amount remains
‘overdue’ for a period of more than 90 days.
(ii) Cash Credit/Overdraft :
The account remains ‘out of order’ for a period of 90 days.

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(iii) Bills Purchased/Discounted:
The bill remains ‘overdue’ for a period of more than 90 days.
(iv) Advances granted for agricultural purposes:
The interest and/or instalment of principal amount remains
overdue for two harvest seasons but for a period not exceeding
two half year.
(v) Other Accounts:
Any amount to be received remains ‘overdue’ for a period of
more than 90 days.
(vi) As per RBI guidelines, if one account of the borrower becomes
Non-Performing Asset (NPA), all other accounts of the same
borrower should also be classified as NPA account (Sub-
Standard Asset)(even if the account is standard asset).

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(6) Provisioning for NPA Accounts :
As per RBI guidelines, the banks have to create provision out of
their profit every year, for the Non-Performing Assets. For the
calculation of provisioning requirements, Bank should assess the
realisable value of available securities and classify the account
into secured (secured by securities) and unsecured portion (no
securities). The provision has to be made for both secured and
unsecured portion. For unsecured portion of loan, provision is
required to be made at 100% of the amount outstanding in the
loan accounts. The amount of provision for various classes of
advances (bad advances) (NPAs) are detailed below:
(i) Standard Assets (SA) (Loans):
Provision is to be made at 0.40% of the loan outstanding
amount in the account.
(ii) Sub-standard Assets (SSA) (Loans):
Secured portion : 15% on the outstanding amount.
Unsecured portion : 25% on outstanding amount, in some
cases it is 20%.
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(iii) Doubtful Assets (DA)(Loans):
(a) Upto 1 year :
Secured portion: 25% of the outstanding amount of loan.
Unsecured portion: 100% of the outstanding amount of loan.
(b) More than 1 year to 3 years:
Secured portion : 40% of the outstanding amount of loan.
Unsecured portion: 100% of the outstanding amount of loan.
(c) More than 3 years:
Secured portion : 100% of the outstanding amount of loan.
Unsecured portion: 100% of the outstanding amount of loan.

(iv) Loss Assets (LA)(Loans) :

The entire outstanding amount in the loan account is
considered as unsecured. Accordingly, 100% provision has to
be made on the entire outstanding amount of loan.

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(7) Credit Information Bureau (India) Limited (CIBIL) :
CIBIL has been set up in January 2001 to serve as an effective
mechanism for exchange of information between banks and
Financial Institutions (FIs) for curbing growth of NPAs.
(i) Banks and FIs should submit a list of suit filed accounts of Rs 1
crore and above to CIBIL in the prescribed form for maintaining
data base.
(ii) The same data should also to be submitted to RBI for declaring
the borrowers in their list of defaulters.
(iii) All banks should refer to CIBIL the name of the prospective
borrower for verifying their records and clearance before
extending any loans.
(iv) Such information of default by the borrower is also
shared by the banks through the forum of consortium
arrangement.

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(v) Banks can also retrieve the requirement information regarding
default by the borrower entity or director(s) or partner(s) from
the web site of CIBIL.
(vi) For any sanction of new loan or enhancement of existing loans
and advances, clearance from CIBIL is essential and the report
from CIBIL should be annexed to the credit proposal for decision
making.
(vii) No loans or advances shall be sanctioned by the banks to the
borrower(s) or director(s) or partner(s) who name is mentioned
in the defaulters list of CIBIL.

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(8) Impact of NPA in the banks :
(i) Profitability : Affects the profit of the bank due to reduction in
interest income and higher provisioning.
(ii) Asset (credit) contraction : Increased NPAs put pressure on
recycling of funds and results lesser interest income to the
banks.
(iii) Liability Management : Affects Net Interest Margin (NIM)
since banks tend to lower interest on deposit due to reduction
in interest income on account of NPAs.
(iv) Capital Adequacy : Affects the CRAR due to RWAs which
includes NPAs. Higher capital for low quality of assets.
(v) Shareholders’ confidence : NPAs affect the Return on Capital
on account of lesser dividend arising out of low profit and
provisioning for NPAs.
(vi) Public confidence : Trust on the bank in the eyes of publis is
also affected due to NPAs. Public may get doubt about the
soundness of the bank and safety of their deposits.
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(9)Measures undertaking by banks to reduce the level of
Non-Performing Assets (NPAs) :
Since the Non-Performing Assets (NPAs) have a direct bearing
on the earnings and profitability of a bank, many measures
have been taken by the banks, under the guidelines of RBI, in
order to reduce the level of NPAs. Some of these measures are
mentioned below:
(i) Identifying potential NPAs for effectives follow-up.
(ii) Taking earnest efforts to recover and regularise the accounts
which have turned out to be NPAs for the first time.
(iii) Making vigorous follow-up of all suits filed and long pending
NPAs.
(iv) Installing a sophisticated software to monitor and manage the
bank’s NPA accounts and also for Early Alert System to help the
banks to take timely steps to prevent accounts becoming NPA.

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(v) Constituting Exclusive Cells at Head Offices, Regional Offices
and major branches to speed up the recovery process.
(vi) Taking action under the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Act (SARFAESE
Act) 202, for the recovery of loans and advances from the
borrowers.
(vii) Taking recourse to the compromise route to settlements
whenever, the proposals are found to be reasonable.

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 (10)(i) Assignment :
ABC Company Limited has been sanctioned the following credit
facilities by Fairdeal Bank and the position of accounts as on
31.03.2014 is as below.
Facility Limit (Rs) outstanding balance (Rs)
Cash Credit 5,00,000 6,00,000
Term Loan 5,00,000 4,00,000
Overdraft account 5,00,000 4,00,000

In Cash Credit account interest has not been paid by the

Company for more than 90 days as on 31.03.2014, while in
other two accounts interest amount was paid. Identify the
NPA accounts of the Company and the total amount of NPA
amount.

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(10)(ii) Assignment :
Mr A is Chairman of ABC Company. The Company, has been
sanctioned comprehensive credit facilities by the Fairdeal Bank.
Details of amounts disbursed are as under :
(i) Cash Credit : Rs 5,00,000 of which the Company purchased
raw-material worth Rs 1,00,000 for its associate Company –XYZ
Company.
(ii) Term Loan : Rs 50,00,000 for construction of factory building
and machinery. Of this amount, he has constructed his own
residential house within the factory complex for Rs 20,00,000

Questions : (a) Is there any diversion of funds ? (b) If so, what is

the amount diversion of funds by Mr A, from out of the loans
sanctioned to ABC Co. Explain with reasons.

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THANK YOU

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