CHAPTER 10: ASSET CLASSIFICATION

OBJECTIVES

 definition of Non-Performing Assets (NPA)

 standard assets
 sub-standard assets O doubtful assets
 loss assets

INTRODUCTION

Loans and advances of banks appear on the asset side of the balance sheet

Classified as assets.

Aim of banks: (a)To recover interest on their loans and advances and

b) principal amount comes back as stipulated at the time of sanctioning loans.

 If the payment of interest and the principal amount or the instalments are delayed/
defaulted an account is said to be overdue.
 If the accounts remain overdue or past due beyond the stipulated time the accounts are
classified as NPA.
 In the case of NPA accounts the banks cannot recognize the income.
 If the assets are NPA for some time the banks will have to provide for loan losses.

As per RBI’s regulatory guidelines, Banks classify loan assets as-

 standard assets,
 sub standard assets,
 doubtful assets and
 loss assets.

DEFINITION OF NPA

In terms of RBI guidelines –

 Prudential Norms on Income Recognition,

 Asset Classification and
 Provisioning pertaining to Advances are as under:

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:

(i) Interest and/or instalment of principal remains overdue (unpaid) for a period of more
than 90 days in respect of a term loan,
(ii) The account remains 'out of order' for a period of more than 90 days (the outstanding
balance being in debit or in excess of the limit sanctioned) in respect of an
overdraft/cash credit,
(iii) The bills remains overdue (unpaid) for a period of more than 90 days in case of the bills
purchased and discounted,
(iv) The instalment of principal or interest thereon remains overdue for two crop season for
short duration crops in case of agriculture finance,
 (v) The instalment of principal or interest thereon remains overdue for one crop season for
long duration crops,

Banks should classify an account as NPA if the interest charged during any quarter is not
serviced fully within 90 days from the end of the quarter.

An account should be treated as out of order' if the outstanding balance re-mains

continuously in excess of the sanctioned limit/drawing power.

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 the 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'.

A) STANDARD ASSETS

RBI guidelines stipulate that banks must classify assets or loans into four categories:

 Standard Assets NOT NPA

 Sub-standard Assets NPA
 Doubtful Assets NPA
 Loss Assets NPA

An asset is either NPA or non-NPA.

NPA accounts can be further classified into the sub-categories:

 Sub-standard,
 Doubtful and
 Loss assets.

Standard assets features-

 Are those that service their interest and principal instalments on time
 Are called performing assets as they yield regular interest to the bank and return the due
principal.
 The retail loan debtors under performing loans will normally pay the monthly instalments
dues (EMI) regularly and in time.

The following three NPA categories of debtors will, however, be marked by

delay/avoidance/resistance in payment of the overdue amount, due to their financial difficulty or
unwillingness to pay or similar other reasons.

NPAs are characterized by—

 non-servicing of interest and

 non servicing of principal as, per stipulations.

B) SUB-STANDARD ASSETS

 Assets which have remained NPA for a period upto 12 months.

Example: To illustrate if 3 EMIs of a loan remain unpaid for a period of over 90 days but less
than 12 months, the account will be treated as Sub-standard asset.
  The collection of sub-standard assets will become progressively difficult. For example

Example: If the default period is 91 days, it may be less difficult to collect the overdue amount
as compared to an account which is in default for longer period periods. When the default period
increases to, say, 6 months, the overdue amount will increase due to 6 months EMI in default (as
compared to 3 months earlier) and also additional interest on the overdue amount added up.

C) DOUBTFUL ASSETS

 An asset would be classified as doubtful if it has remained in the sub-standard category for a
period of 12 months. Their recovery seems improbable and highly questionable.
 It is worsening of sub-standard asset as they have remained unpaid for at least 12 months
since they were classified as Sub-standard asset.
 It would be more difficult to collect the overdue amount in Doubtful assets, as the overdue
amount relates to additional 12 months (or more) along with additional interest.

D) LOSS ASSETS

 A loss asset is one where loss has been identified by the bank or its internal or external
auditors, or by the RBI inspection, but the amount has not been written off wholly.
 Loss assets are considered uncollectible. They are of such little realisable value that their
continuance as bankable assets is not warranted.
 There may be some salvage value in the long term, in some cases.

Under Asset Classification, the probability of repayment of loans in four categories will generally be:

 High in Standard assets,

 Good or fair in Sub-standard assets,
 Doubtful or Questionable in Doubtful assets, and
 Improbable or negligible in Loss Assets

Before a loan account turns into an NPA, banks are required to identify incipient stress in the
account by creating three sub-categories under the Special Mention Account (SMA) category as
given in the table below:

SMA SUB CATEGORIES BASIS FOR CLASSIFICATION

SMA-0 Principal or interest payment not overdue for more than 30 days but
account showing signs of incipient stress
SMA-1 Principal or interest payment overdue between 31-60 days
SMA-2 Principal or interest payment overdue between 61-90 days

ASSET CLASSIFICATION IN BUCKETS

Banks which employ collection agents, use time buckets to group the defaults based on the period of
default.

 Time bucket classification could vary from bank to bank.

 The first bucket includes those accounts which are overdue for a period of less than 91 days.
 When the default period increases the banks will move the dues to next bucket. (Banks
often say that "the account has slipped into the next bucket").
 Purpose of classification into time buckets :
 To focus on recovery and
 to ensure that the accounts do not go into longer buckets.
 Accounts in longer buckets call for different collection strategies than those which are in the
first bucket.