VERIFICATION OF ADVANCES - IRAC norms & practical issues

1. VERIFICATION OF ADVANCES - IRAC norms & practical issues Radhesh L. Bhat FCA

2. TOPICS COVERED • Verification of advances – vis. a vis RBI guidelines • Asset Classification/provision norms • Practical issues

3. 90 days norms • TL- Interest/ Principal O/s for > 90 days • OD/CC- “Out of Order” • Balance exceeding DP/Limit • No credits/ insufficient credits • BP – Bills remains overdue for more than 90 days • Long Duration- overdue for 1 crop season • Short Duration- overdue for 2 crop season

4. Other NPA norms (4.2.4 of MC) • Accounts with temporary deficiencies • if not renewed/reviewed within 180 days from due date - NPA • Adhoc limit if not renewed/reviewed within 180 days from due date -NPA [Applicable for good accounts also] • Central Govt. Guaranteed Advances only for NPA classification, not for income recognition • No exemption for State Govt. guaranteed

5. 90 days norms- Practical Considerations • Stock statement - not to be older than 3 months. If yes irregular. • Hence maximum 6 months • Verify contents of stock statement • Concept of paid stock • Non moving stock/debtors > 6 months • Physical verification – significance

6. 90 days norms- Practical Considerations • Comparison with PY end stock statement vis a vis financials– wide variation? • Stock audit • Bank’s policy of computation

7. 90 days norms - Practical Considerations • Interest due & charged in a qtr– 90 days from end of quarter (2.1.3 of MC) • Concept of Overdue – Interest debited - – whether internal guidelines of 1 week/1 month applicable??? • Beware of reversal entries – mistaken as credits • To see day end balance (Intra day credits)

8. 90 days norms- Practical Considerations • Beware of solitary credits near the Balance Sheet Date • Credits from other accounts/other branches to regularise the account-check genuineness • Continuously in excess, except for a few days at the end - mention In report • Technically NPA at the year end – apply professional judgement – see the health of the account • Availability of security/ networth – not a criteria for not treating as NPA

9. 90 days norms- Practical Considerations • Check SMA list of February 2016 • RBI/ Internal Inspection/ RBIA commented accounts • Check position with other banks in case of Joint lending/Consortium

10. 90 days norms- Practical Considerations • Bills purchased/ discounted • over due from due date • extension of due date vis a vis restructuring • Beware of year end regularisation by chq purchase- Cheque Purchased on 31.3, not cleared on date. • Packing credits – extension permitted within 90 days norms upto 360 days - To obtain letter from foreign buyer seeking extension of delivery of goods

11. Early detection - SMA : Not overdue for > 30 days • Banks to report to Central Repository of information on large credits of RBI (CRILC) Rs.50 million and above • If Aggregate exposure >Rs.1000 mn - JLF to be formed – JLF to decide Corrective Action Plan • Refer Appendix to Part C-1 of MC 2015 for illustrative list of signs of stress

12. Failure in Early detection • Accelerated provisioning norms to apply (apart from other supervisory actions) if: • banks fails to report SMA status of the accounts to CRILC or • resort to methods with the intent to conceal the actual status of the accounts or • evergreen the account Refer para 31 of MC – July 2015 for accelerated rates

13. Master Circular – Rupee/Foreign Currency Export Credit and Customer Service to Exporters dt July 1, 2015 Pre Shipment/ Packing credit- • Granted to exporter for purchase/processing/manufacture/ packing/ WC expenses for services • On the basis of L/C or confirmed Order • If pre shipment is not adjusted within 360 days, cease to qualify for prescribed ROI. • Liquidation – Out of bills drawn/ EEFC

14. Master Circular – Rupee/Foreign Currency Export Credit and Customer Service to Exporters dt July 1, 2015 • Pre Shipment/ Packing credit- Operational Flexibility • Single A/c or Running A/c Facility - Mark off export bills on FIFO basis- 360 days • Liquidate though Export documents of any other order (Account in same bank/permission of consortium)- • Risk that exporter may avail of export from one bank and submit documents to another

15. Master Circular – Rupee/Foreign Currency Export Credit and Customer Service to Exporters dt July 1, 2015 • Export Credit in foreign Currency • PCFC is for a maximum of 360 days. • If exceeds 360 days, PCFC is adjusted against TT Selling rate (crystallisation)

16. Verification of advances - • Industries with stress: • Real estate, Retail, Automobiles, Etc…… • Large Unfunded exposures – esp LC - frequent devolvement of LC–serious threat • Test check RBI guidelines for acceptance of LC/BG followed • Reporting of excess sanction to higher authorities

17. Asset classification • Borrower wise – not facility wise • Exceptions: • Advance against NSC/FD • Bills discounted under LC of other banks- not to be treated as NPA even if other facilities are NPA, unless the other bank refuses to accept the documents under LC

18. Asset classification • Upgraded during the year– Restructured / others – - ensure strict compliance of norms. • Bank’s classification may not be adequate. • Temporary deficiencies – case to case depending upon health.

19. Asset classification Advances under consortium – • based on individual bank’s share of recovery. • Classification independent of member banks • However, to see classification status of other bank in case of stressed accounts.

20. NPA classification – erosion in value of security/fraud • If realisable value is <50% of assessed value – straight away doubtful • If realisable value < 10% of outg balance in loan accounts – straight away loss assets. • Such accounts need not go through various stages of classification

21. Asset classification • Housing loans – large single repayment during the year/previous year • Agri advances : depends upon crop season (long/short duration) • Long – crop season longer than 1 yr • crop season – period of harvesting determined by State level committee of banks of each state.

22. Asset classification Govt guaranteed advances: • state govt = normal classification – 90 days norms • Central Govt: only if govt repudiates guarantee when invoked.

23. Take over loans • Existing classification to be retained. • Not healthy to take over NPA loans • Provisioning based on original date of becoming NPA, as if it were existed in the books of the bank • Obtain status report from the other bank

24. Export projects finance • If borrower remitted to bank abroad, but the bank in turn is unable to remit the amount due to political developments such as war, strife, UN embargo, etc. - Not to be treated as NPA, • Asset classification starts after 1 year of such remittance • Obtain evidence of remittance directly

25. Credit card accounts • 90 days norms start from date of next statement • Not more than 30 days gap between 2 statements • With reference to the minimum due

26. Project loans - DCCO • The ‘Date of Completion’ and the ‘Date of Commencement of Commercial Operations’ (DCCO), of the project should be clearly spelt out at the time of financial closure of the project and the same should be formally documented. • These should also be documented in the appraisal note by the bank during sanction of the loan

27. Project loans – Deferment of DCCO is NPA Exceptions: (refer para 4.2.15.3 of MC) if Revised DCCO falls :- • Within 2 years of original DCCO for INFRA projects • Within 1 year for Other than INFRA projects (including CRE) • All other terms and conditions of the loan remain unchanged & • Attract standard asset provision of 0.40 %

28. Project loans – Deferment of DCCO is NPA Exceptions Continued….. • If delay involves involving court cases – additional 2 years (apart from the above 2 years – total 4) • If delay due to reasons beyond control of promoters – additional 1 year (total 3) • For Non – Infra (other than CRE) – upto to 1 year (total 2) If the a/c continues to service as per restructured terms.

29. Project loan – general • A project may be classified as NPA during any time before commencement of commercial operations as per record of recovery (90 days overdue)

30. Project loan – general • The dispensation stated in above is subject to the condition that the application for restructuring should be received before the expiry of normal period of 2/1 year and • when the account is still standard as per record of recovery. • no change in any other loan conditions • Certain other conditionsapplicable :

31. Other conditions: • In cases where there is moratorium for payment of interest - banks should not book income on accrual basis beyond 2/1 year/s from the original DCCO for infra/non-infra projects respectively (considering the high risk involved) • Banks should maintain additional provisions on such accounts as long as these are classified as standard assets (in addition to provision for diminution in fair value due to extension of DCCO) • Refer page 13 of MC 2015

32. Additional provisions chart –

33. Change in DCCO – Concession authority DCCO need not be treated as ‘restructuring’, subject to following conditions: • a) The project is an infra project under public private partnership model awarded by a public authority; • b) The loan disbursement is yet to begin; • c) The revised DCCO is documented by way of a supplementary agreement between the borrower and lender and; • d) Project viability reassessed/ sanction obtained from appropriate authority at the time of supplementary agreement.

34. Project loans – Change in repayment schedule (para 4.2.15.5 of MC) Any change in the repayment schedule of a project loan caused due to an increase in the project outlayon account of increase in scope and size of the project, would not be treated as restructuring if: • The increase in scope and size of the project takes place before commencement of commercial operations of the existing project. • The rise in cost excluding any cost-overrun in respect of the original project is 25% or more of the original outlay. • The bank re-assesses the viability of the project before approving the enhancement of scope and fixing a fresh DCCO. • On re-rating, (if already rated) the new rating is not below the previous rating by more than one notch.

35. Project loans – Multiple revision in DCCO Multiple revisions of the DCCO and consequential shift in repayment schedule for equal or shorter duration (including the start date and end date of revised repayment schedule) will be treated as a single event of restructuring provided that • the revised DCCO is fixed within the respective time limits stipulated at paragraphs 4.2.15.3 (ii) above, and • all other terms and conditions of the loan remained unchanged.

36. Restructuring – General • All other aspects of restructuring of project loans would be governed by the provisions of Part B of the Master Circular on Prudential norms on Income Recognition, Asset Classification and Provisioning Pertaining to Advances

37. Restructuring – to Sum up • Refers to change in any terms and conditions • Downgraded immediately on restricting (exceptions – deferment of DCCO) • Relaxations - only for project loans (refer para 4.2.15.3 of July 2015) • No new restricting under earlier restructuring schemes, after 31.03.2015

38. Revenue recognition • Normally under accrual basis • On cash basis for NPA cases • Cases of non reversal of URI in NPA (manual/software)- test check • Beware of FITL – on cash basis for NPAs

39. Provisioning – General - Provisioning norms only for funded exposure • Loss -100% (irrespective of security) • Doubtful – Unsecured-100% • Doubtful – secured - 3 stages • Only tangible security considered

40. Sub Standard – provision • General provision – 15% [security/ECGC cover not to be considered] • SS – Unsecured – Additional 10% (total 25%) [‘Unsecured’- Realisable value of security as assessed is not more than 10%, ab initio, of outg exposure - Exposure for this purpose includes funded and non funded] • Exception – Infra where escrow account is available – 20%

41. Projects under Implementation – Change in Ownership (New) Joint Lenders’ Forum (JLF) can consider such change in ownership under Strategic Debt Restructuring Scheme if • the borrower is not able to come out of stress due to operational/ managerial inefficiencies despite substantial sacrifices made by the lending banks • fail to achieve the projected viability milestones as per CDR/JLF mechanism - Without affecting the asset classification status

42. CDR • Multiple banking > Rs. 10 crs exposure • SME Debt Restructuring Mechanism upto Rs.10 crs. • Date of admission to CDR cell is important (not mere application) • Conditions strictly to apply during the period of CDR

43. Other points • Relying on other inspection/audit reports • Flash report/exception report • Report on exceeding delegation of authority. • Verify the sanction terms fed in software system

44. Verification of revenue leakage – Test check • Processing charges, insurance, etc • Interest on advances, penal interest on overdues (check whether fed in CBS) • Charges for non submission/late submission of stock statements, non renewal of limits, charges for inspection/stock audit, valuation etc.

45. Symptoms of Stress - Examples • Accounts remain mostly above limit • Frequent cheque bouncing/dishonour • Frequent TOD sanctioned and outstanding • Turnover in loan account much lower than purchase/sale of stock • Discounted bills remain unrealised • Frequent LC devolvement • Non submission of stock statements/financials on time • Submitted stock statements are not proper and mismatch between audited figures/ stock audit reports • Ad – hoc limits/ Delay in renewal of limits • Undue delay in commencement of projects • Funded/unfunded limits not commensurate with operations • Bills discounting disproportionate to operations (accommodation) • Specific economic conditions affecting the borrower

46. Reports available in CBS • Devolvement/ Invoking/ Crystallization • Cheque Purchased O/s • Borrower Wise Loans- Funded and Non Funded • Security Valuation and Provisioning for NPA • Account Exceedings Report • Sector Wise Exposure • SMA lists on various dates • Accounts upgraded during the period • Fresh sanctions during the period

47. PRACTICAL CASES

48. Drawing Power - Working capital • Periodic inspection by branch officials • Stock audits • Checking with financials/ VAT Returns • Concept of MPBF for computing DP

49. DP under MPBF method - Illustration

50. Drawing power –Illustration- MPBF Method