NPA Classification

Non-Performing Assets (NPAs) are one of the most critical topics in banking and are heavily tested in the JAIIB exam. An NPA is a loan or advance where the borrower has stopped making interest or principal payments. Understanding NPA classification, income recognition norms, and their impact on a bank's financial health is essential for every banking professional.

An asset (loan/advance) becomes non-performing when it ceases to generate income for the bank. As per RBI guidelines:

• Term Loan: NPA if interest and/or instalment of principal remains overdue for a period of more than 90 days
• Overdraft/Cash Credit: NPA if the account remains out of order for more than 90 days
• Bills Purchased/Discounted: NPA if the bill remains overdue for more than 90 days
• Agricultural Loans: NPA if overdue for 2 crop seasons (short duration) or 1 crop season (long duration)

Out of Order

An OD/CC account is treated as "out of order" if:

• Outstanding balance exceeds the sanctioned limit/drawing power continuously for 90 days, OR
• There are no credits in the account for 90 days, OR
• Credits are not enough to cover the interest debited during the same period

NPAs are classified into three categories based on the period of default and realisability:

Sub-Classification of Doubtful Assets

Day 0: Loan disbursed (Standard Asset)
Day 91: Account overdue > 90 days → NPA (Sub-Standard)
Day 91 + 12 months: Still NPA → Doubtful (D1)
D1 + 1 year: → Doubtful (D2)
D2 + 2 years: → Doubtful (D3)
If loss identified: → Loss Asset

Standard Assets

• Income (interest) is recognised on accrual basis

Non-Performing Assets

• Income recognition is on cash basis only
• Interest accrued and not received must be reversed from the P&L Account
• Any interest already credited to income must be reversed if the account becomes NPA
• Interest on NPAs is recognised only when actually received in cash

Key Rules

• Banks should not charge and take to income account any interest on NPAs
• Interest that was already accrued and credited must be reversed or provided for
• Fees and commissions on NPAs should also be recognised only on cash basis

An NPA can be upgraded to Standard if:

• All arrears of interest and principal are paid by the borrower
• The account shows satisfactory performance
• For accounts restructured under various schemes, specific norms apply

Narasimham Committee I (1992)

• Introduced IRAC norms (Income Recognition and Asset Classification)
• Brought focus on credit risk and recovery management
• Led to progressive reduction in CRR and SLR
• Introduced Capital Adequacy Norms
• Recommended establishment of Debt Recovery Tribunals (DRT)

Narasimham Committee II (1998)

• Recommended raising capital adequacy to 9% (from 8%)
• Introduced concept of Narrow Banking for weak banks with high NPAs
• Recommended merger of strong banks for "multiplier effect"
• Suggested review of bank ownership and autonomy

Other Reforms

• SARFAESI Act, 2002: Enables banks to recover NPAs without court intervention
• Asset Reconstruction Companies (ARCs): Buy NPAs from banks at a discount
• IBC (Insolvency and Bankruptcy Code), 2016: Time-bound resolution (180 + 90 days)
• Prompt Corrective Action (PCA): RBI framework for banks with deteriorating asset quality

Before an account becomes NPA, it may be classified as SMA:

SMA classification helps in early warning and proactive management of potential NPAs.

A borrower is classified as a wilful defaulter if they:

• Have defaulted despite having the capacity to pay
• Have diverted funds for purposes other than stated
• Have siphoned off funds
• Have disposed of secured assets without bank's permission

Banks cannot extend additional facilities to wilful defaulters.

• NPA = loan overdue for more than 90 days (standard rule)
• Agricultural loans: 2 crop seasons (short) or 1 crop season (long)
• Sub-Standard: NPA up to 12 months; Doubtful: beyond 12 months; Loss: identified as irrecoverable
• Income on NPAs recognised on cash basis only — accrued interest must be reversed
• Gross NPA Ratio = Gross NPA / Gross Advances x 100
• Net NPA = Gross NPA - Provisions - Interest Suspense
• Narasimham Committee I (1992) introduced IRAC norms
• Narasimham Committee II (1998) recommended 9% capital adequacy
• SARFAESI Act allows recovery without court intervention
• SMA-0/1/2 classification provides early warning before NPA status
• Wilful defaulters cannot receive additional bank facilities
• OD/CC is "out of order" if no credits for 90 days or balance exceeds limit for 90 days