🏦 NPA
Comprehensive guide on NPA, IRAC norms, Out of Order status, special cases, income recognition, and recovery or restructuring-based upgradation.
Non-Performing Assets (NPA)
Overview of Non-Performing Advances (NPA)
An NPA is essentially a loan or advance where the borrower has stopped making interest or principal repayments for a significant period.
- Regulatory Origin: NPA guidelines were introduced by the Reserve Bank of India (RBI) based on the recommendations of the 'Committee on the Financial System' led by Shri M. Narasimham.
- Goals: To forcibly improve consistency and transparency in bank accounts. Income recognition should be strictly based on actual recovery, preventing banks from hiding losses using subjective factors.
- Formal Name: These are officially known as the 'Prudential Guidelines on Income Recognition, Asset Classification and Provisioning'.
- Effective Date: These guidelines came into effect on March 31, 1993.
Primary Reasons for NPA:
- Non-compliance with sanction conditions: This includes delays or non-repayment of the principal/interest amount and the failure to renew sanctioned working capital limits.
- Loss of Security: If the collateral/security against which the loan was given is no longer available or has lost its value significantly.
General Criteria for an Account Becoming NPA
An account is classified as an NPA if the payment is overdue for a specific period (usually more than 90 days).
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Non-Performing Assets (NPA)
Overview of Non-Performing Advances (NPA)
An NPA is essentially a loan or advance where the borrower has stopped making interest or principal repayments for a significant period.
- Regulatory Origin: NPA guidelines were introduced by the Reserve Bank of India (RBI) based on the recommendations of the 'Committee on the Financial System' led by Shri M. Narasimham.
- Goals: To forcibly improve consistency and transparency in bank accounts. Income recognition should be strictly based on actual recovery, preventing banks from hiding losses using subjective factors.
- Formal Name: These are officially known as the 'Prudential Guidelines on Income Recognition, Asset Classification and Provisioning'.
- Effective Date: These guidelines came into effect on March 31, 1993.
Primary Reasons for NPA:
- Non-compliance with sanction conditions: This includes delays or non-repayment of the principal/interest amount and the failure to renew sanctioned working capital limits.
- Loss of Security: If the collateral/security against which the loan was given is no longer available or has lost its value significantly.
General Criteria for an Account Becoming NPA
An account is classified as an NPA if the payment is overdue for a specific period (usually more than 90 days).
| Account Type | Criteria for NPA Classification |
|---|---|
| Term Loans | Principal or interest remains overdue for more than 90 days. |
| Cash Credit (CC) / Overdraft (OD) | The account remains "Out of Order" for more than 90 days OR the sanctioned limit is overdue for renewal for more than 180 days. |
| Bills Purchased/Discounted | The bill remains overdue for a period of more than 90 days. |
| Securitisation | Outstanding liquidity is overdue for more than 90 days. (Simplified: When a bank bundles up loans and sells them as an investment package. If the expected cash flows are delayed for >90 days, it is an NPA.) |
| Derivatives | Unpaid positive mark-to-market values are overdue for more than 90 days. (Simplified: A derivative is a financial contract (like a bet on currency rates) between the Bank and a client. "Mark-to-market" means recalculating the contract's value daily based on current market prices. A positive value means the market moved in the Bank's favor, so the client owes the bank money to cover the difference. If the client fails to pay this owed money to the Bank for >90 days, it becomes an NPA.) |
| Credit Card Accounts | If the Minimum Amount Due (MAD) is not paid within 90 days. |
| Other Accounts | Any amount to be received remains overdue for more than 90 days. |
Interest Payment & The "Day-End Process" Rule
- Historically, the RBI allowed a "buffer" where the 90-day clock only started at the close of the quarter in which the interest was charged. This rule is now OBSOLETE. Do not fall for exam questions trying to trick you with the old "quarter-end buffer."
- Current RBI Norm: To align with international standards, the RBI has moved to a strictly overdue-based system.
- An account is classified as an NPA if the interest remains overdue for more than 90 days from the EXACT due date, regardless of financial quarters.
- The Day-End Process: Banks are now mandated by the RBI to identify NPAs on an ongoing, daily basis through their computerized "day-end process." [1]
- Example: If interest is charged and becomes due on May 30th, the 90-day clock starts ticking immediately on May 30th. There is no waiting for the quarter to close on June 30th. If unpaid, the account becomes an NPA exactly 90 days later (around August 28th).
- To catch early stress before the 90-day mark, the RBI uses Special Mention Accounts (SMA):
- SMA-0: Overdue 1–30 days.
- SMA-1: Overdue 31–60 days.
- SMA-2: Overdue 61–90 days.
- If the dues are still not cleared by the end of SMA-2, it instantly becomes an NPA.
Loans with Interest Moratorium & Staff Loans
- For massive industrial or agricultural projects granted an interest moratorium, the interest explicitly only becomes 'due' post-moratorium.
- Similarly, staff housing loans uniquely classify as NPA only upon default in payments strictly after their scheduled due dates (e.g. after the house is built or the staff member's grace period ends).
Understanding "Out of Order (OOO)" in CC/OD Accounts
For revolving credit facilities like Cash Credit (CC) or Overdraft (OD) accounts, the trigger for NPA classification is when the account becomes "Out of Order". Under the RBI Nov 12, 2021 guidelines, an account is treated as "Out of Order" if any of the following three conditions are met:
1. Limit / Drawing Power (DP) Breach for 90 Days
The outstanding balance remains continuously in excess of the sanctioned limit or the Drawing Power (DP), whichever is lower, for 90 days.
- Important Note: The countdown begins the moment the balance breaches the lower threshold. On Day 1, it becomes irregular (overlimit) immediately, but it is not classified as "Out of Order" (NPA) until it has remained continuously in excess for 90 days.
- Example:
- Sanctioned Limit: 20 Lac | Drawing Power (DP): 18 Lac
- Because DP is lower, the effective limit is 18 Lac. If the outstanding balance hits 18.90 Lac, it exceeds the DP and becomes irregular on Day 1.
- If the borrower fails to bring the balance back down and it remains continuously above 18 Lac for 90 days, it becomes "Out of Order" and is classified as an NPA on the 91st day.
2. No Credits for 90 Days
The outstanding balance is within the limit/DP, but there are no credits in the account for a continuous period of 90 days.
- Change in Assessment: Previously, some assessed this only as of the Balance Sheet date. The RBI clarified that this must be monitored continuously on an ongoing daily basis via the Day-End process.
3. Insufficient Credits for 90 Days
Credits are received, but they are insufficient to cover the interest debited during the previous 90-day period.
SMA Classification for CC/OD Accounts
For revolving CC/OD facilities, the RBI clarified that Special Mention Account (SMA) classification is based on how long the outstanding balance remains continuously in excess of the limit/DP:
| SMA Category | Period in Excess of Limit / Drawing Power |
|---|---|
| SMA-0 | Not Applicable for CC/OD revolving facilities |
| SMA-1 | More than 30 days and up to 60 days |
| SMA-2 | More than 60 days and up to 90 days |
| NPA ("Out of Order") | More than 90 days |
Old Stock Statements & Drawing Power (DP)
Working capital accounts require regular stock and debt statements to determine the Drawing Power (DP):
- Age Limit: Stock statements should not be older than 3 months [1].
- Irregularity Trigger: If drawing power is calculated based on stock statements older than 3 months, the drawings in the account are deemed irregular immediately.
- NPA Trigger: If this irregularity (drawing against stock statements older than 3 months) is permitted to continue for a continuous period of 90 days, the account is classified as an NPA (even if the account is otherwise in order).
Calculation of Drawing Power (DP)
Drawing Power is the actual limit a borrower can utilize based on the value of the current assets (stock/debtors) after deducting a "margin" set by the bank.
Formula: Drawing Power (DP) = Value of Assets - Margin
Example Calculation:
- Stock Value: 28 Lac
- Bank Margin: 30% of 28 Lac = 8.40 Lac
- Sanctioned Limit: 20 Lac
- Calculated DP: 28 Lac - 8.40 Lac = 19.60 Lac
In this case, the borrower can only draw up to 19.60 Lac, even if their sanctioned limit is 20 Lac, because the DP is lower. That is why in norms, it is written that an account is Out of Order if the outstanding balance remains continuously in excess of the sanctioned limit or the Drawing Power (DP) whichever is lower for 90 days. So in this case the account will be OOO if the outstanding balance remains continuously in excess of 19.60 Lac for 90 days.
Farm Credit in Agriculture Loans
Agriculture loans follow a unique timeline for NPA classification because recovery is linked to harvest cycles rather than fixed 90-day periods.[1]
The Historical Shift to Crop-Season Norms
Historically, agricultural advances were classified as NPAs using standard commercial criteria (a standard day-count or quarter-end classification system where accounts became NPAs if overdue for more than two quarters). Because agricultural income is seasonal and realized only after harvesting and marketing of crops, this rigid calendar-based classification caused undue hardship and artificial NPA inflation for farmers.[2]
To address this misalignment, the RBI constituted the Advisory Committee on Flow of Credit to Agriculture and Related Activities (chaired by Prof. V.S. Vyas in 2004). Recommendations of the Vyas Committee were implemented via RBI Circular DBOD.No.BP.BC.26/21.04.048/2004-05 dated July 30, 2004 (effective from September 30, 2004), which officially shifted agricultural advances from the day-count/quarter-end system to a crop-season-based classification system.[2]
Crop-Season Classification Criteria
Under this framework, a loan granted for agricultural activities is classified as an NPA based on crop seasons:
- Short Duration Crops: The loan (principal or interest installment) remains overdue for two crop seasons.[2]
- Long Duration Crops: The loan (principal or interest installment) remains overdue for one crop season.[2]
Key Operational Details:
- Crop Season Definition: A crop season refers to the period up to the harvesting of the crop.
- Classification Authority: Since crop cycles vary significantly across regions, the State Level Bankers' Committee (SLBC) in each state is responsible for determining and declaring which crops in that state are classified as short-duration or long-duration.[1]
- Crop Duration Definitions:
- Allied Activities Exception: The crop-season-based relaxation applies to crop loans (short-term loans for seasonal agricultural operations) and agricultural term loans for crop cultivation. However, for advances granted for allied agricultural activities (such as dairy, poultry, fisheries, piggery, etc.), the standard 90-day overdue rule continues to apply.[1]
Loans Against Liquid Security
Under the RBI IRACP Master Circular, certain loans are exempt from standard NPA "overdue" rules if they are fully backed by high-quality liquid assets.[1]
- Eligible Securities: Bank deposits (FDs), NSC (National Savings Certificate), KVP (Kisan Vikas Patra), and Life Insurance Policies.
- The Relaxation:
- The account remains Standard as long as the value of the security is greater than the balance in the account.[1]
- This is true even if the balance exceeds the sanctioned limit.
- Exclusions: This relaxation is not available for gold loans or loans against Government Securities.
- Example: If a loan against an FD of Rs. 1.50 lac has an outstanding balance of Rs. 1.15 lac, it remains a "Standard" account despite any payment delays because the security comprehensively covers the debt.
Government Guaranteed Loans
The NPA classification status differs significantly depending on whether the guarantee is provided by a State or the Central government, as defined by the IRACP norms.[1]
| Guarantee Type | NPA Rules & Treatment |
|---|---|
| State Govt. | No relaxation. Normal NPA rules apply like any commercial loan, as states rely heavily on central allocations and face localized budget risks.[1] |
| Central Govt. | High relaxation. Kept as Standard without provisions, since sovereign backing and monetary control make an outright default virtually impossible.[1] |
Crucial Exception: If the Central Government explicitly repudiates (refuses to honor) its guarantee, normal NPA rules apply immediately.[1]
Export Financings & EXIM Guarantees
- Post-shipment Supplier's Credit: Under the guarantee/refinance program by the EXIM Bank, EXIM acts as a sovereign-level backstop for international trades. Because of this immense security, delays by a foreign buyer don't immediately threaten the domestic bank's capital. The asset is only flagged as non-performing if EXIM Bank formally refuses to pay after the guarantee is invoked.[1]
- Export Project Finance (Transfer Risk): If a foreign buyer has legitimately paid their dues into a local bank abroad, but foreign political crises, sanctions, or a severe shortage of foreign exchange strictly prevent the funds from being wired back to India, it triggers a "Country Risk". Since this block is entirely beyond the Indian exporter's control, the RBI dictates that the asset's downgrade to NPA is safely deferred for one year from the date the deposit was made abroad. The account remains "Standard" during this 1-year grace period.[1]
Consortium Loans
In consortium lending (where multiple banks lend to one borrower), the asset classification is bank-specific.[1]
-
Classification is based on the conduct of the account with individual banks, irrespective of how other banks in the consortium classify it.[1]
Bank A/c Limit DP O/S A/c status Classification SBI CC
TL50.00
>50.0050.00
>40.0048.00
>39.50Regular Standard BOB CC
TL30.00
>30.0029.00
>25.0029.00
>27.50Irregular for
>2 monthsStandard – SMA IOB CC
TL20.00
>20.0020.00
>15.0021.00
>17.50Irregular for
>10 monthsSub-Standard
Impact of NPA Accounts
-
The "Domino Effect" (Borrower-Wise Classification): Asset classification is strictly borrower-wise, not facility-wise. If any single credit facility of a borrower becomes an NPA, all other credit facilities granted to that borrower by the same bank are automatically downgraded to NPA, even if those other accounts are perfectly regular and not overdue.[1]
-
Statutory Exemptions to the Borrower-Wise Rule: The RBI allows specific exceptions where this cross-infection rule does not apply:[1]
- Liquid Securities: Loans fully backed by term deposits (FDs), LIC policies, or NSC/KVP/IVPs (provided they maintain adequate margin).
Note on IVPs: IVP stands for Indira Vikas Patra, a bearer savings certificate launched in 1986. Because it was a bearer instrument (susceptible to misuse for unaccounted wealth), the Government stopped issuing new IVPs in 1999. However, the RBI continues to list "IVPs" verbatim in its current IRACP master circulars as a historical legacy, which is why it remains in the statutory exemptions list today.
- Letter of Credit (LC) Bills: Bills discounted under a valid LC issued by a first-class bank (as long as the bill itself is not overdue).
How this works (Buyer & Seller): Imagine a Seller (the borrower) sells goods to a Buyer. The Buyer's bank issues an LC guaranteeing payment in 90 days. The Seller takes this LC-backed bill to their own bank to get cash immediately ("discounting" the bill). Because the Seller's bank is relying on the Buyer's bank guarantee rather than the Seller's financial health, this specific bill facility is immune from the "domino effect." If the Seller's other loans become NPA, this LC bill stays Standard. However, if the Buyer's bank fails to pay on the 90th day, the bill itself becomes overdue and loses this immunity.
- PACS / FSS On-lending: Loans granted by a bank to Primary Agricultural Credit Societies (PACS) or Farmers Service Societies (FSS) specifically for "on-lending" to their members.
How On-Lending Works: The commercial bank gives a bulk loan to the PACS, which then distributes that money as smaller micro-loans to individual farmers. If an individual farmer defaults on their micro-loan, the commercial bank does not classify its entire bulk loan to the PACS as an NPA. The bank's classification is based solely on whether the PACS itself is meeting its overall repayment obligations to the bank.
- Liquid Securities: Loans fully backed by term deposits (FDs), LIC policies, or NSC/KVP/IVPs (provided they maintain adequate margin).
-
Income Recognition Policy (Accrual vs. Cash):[1]
- Standard Assets: Because a standard borrower is financially healthy, interest is confidently recognized on an accrual basis (recorded as bank income the moment it legally becomes due, assuming it will reliably be paid).
- NPA Assets: Once an account becomes an NPA, the borrower's fundamental ability to pay is broken. Recording unpaid interest would artificially inflate the bank's "paper profits." Therefore, interest must be strictly recognized on a cash basis (only counted as income when physical cash is actively recovered). Furthermore, any pre-existing unrecovered interest that was already accrued must be forcibly reversed from the bank's profit and loss account.
Recovery and Restructuring
There are two ways an NPA account can return to "Standard" status.
A. Recovery (Immediate Upgrade)
- If the entire due amount is recovered, the account is upgraded to the Standard category immediately.
- Crucial Rule: An NPA is absolutely not cured by a partial payment. An NPA can only be upgraded back to 'standard' upon the absolute full payment of all arrears of interest and principal. [1]
- Multi-Facility Rule (Borrower-Wise Upgradation): If a borrower has multiple credit facilities with a bank and any of them is classified as an NPA, all the accounts must be fully regularized (clearing all arrears of interest and principal across all facilities) for any of the accounts to be upgraded to Standard. Paying off arrears for only one account while another remains in default will not allow upgradation. [1]
- Window Dressing Caution: Banks must remain highly cautious of accounts that are "mysteriously" regularized just before the annual balance sheet date. Borrowers aggressively inject short-term funds merely to dodge the NPA reporting stamp, only to withdraw the funds immediately after.
B. Restructuring (Delayed Upgrade)
- The account is upgraded to Standard only after regular repayment for one year based on the new (restructured) due dates.
- Example: If a loan is restructured on May 12, 2017, and repayments start on Dec 31, 2017, the account will only be upgraded to Standard on Dec 31, 2018, provided the borrower paid regularly throughout that year.
References
2 sources • [1] [2]
References
Used for: The primary RBI Master Circular (RBI/2021-2022/125 DOR.STR.REC.68/21.04.048/2021-22) dated November 12, 2021, detailing the day-end identification process, CC/OD out-of-order conditions, 3-month DP stock statements, and borrower-wise upgradation rules.
Used for: RBI Circular dated July 30, 2004 (effective from September 30, 2004), which adopted the Vyas Committee recommendations to shift agricultural NPA classification from standard day-count or quarter-end buffers to a harvest/crop-season-based system.
Summary Cheat Sheet
| Concept | Key Detail |
|---|---|
| NPA Trigger (General) | Principal / interest overdue for more than 90 days |
| CC / OD Rule | Out of order (overlimit/no credits/interest cover) for more than 90 days or renewal overdue for more than 180 days |
| Drawing Power | DP = Value of Assets - Margin |
| Farm Credit | Short-duration: 2 crop seasons; Long-duration: 1 crop season |
| Liquid Security | Loan remains Standard if security value exceeds balance |
| Government Guarantee | Central Govt: standard unless guarantee denied; State Govt: normal NPA rules |
| Export Project Finance | NPA downgrade safely deferred for 1 year if blocked by foreign country risk |
| Consortium Loans | Classification is bank-specific, not common across the consortium |
| Borrower-Wise Effect | One NPA makes all accounts of that borrower NPA within the same bank |
| Borrower-Wise Exemptions | LC Bills (if not overdue) and PACS On-lending micro-loans are exempt |
| Income Recognition | Standard asset: accrual basis; NPA: cash basis |
| NPA Upgradation | Only on full payment of all arrears across all facilities of the borrower |
| Restructuring Upgrade | Becomes standard after 1 year of regular repayment on revised terms |
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