Important amendments to IRAC norms for bank branch auditors-2022

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amendments to IRAC norms for bank branch auditors

Prior to 1992, banks used to recognize interest on the whole portion of loans and advances, regardless of whether each loan advanced was good or poor. As a result, the following drawbacks have occurred. Banks formerly recognized interest on bad loans. Due to recognition of Interest on Income on full loans and advances it was impossible for the reader of Balance Sheet the true financial health of the Bank. Banks used to pay income tax return on even the interest component of bad loans. It was difficult to establish accountability for bank employees in relation to bad loans provided. In this article we will discuss important amendments to IRAC norms for bank branch auditors. 

Table of Content

Background 

The M.Narismhan Committee, established by the Reserve Bank of India to report on the Financial System of Banks, issued various recommendations in 1992. One proposal was that income recognition should be objective and based on a track record of recovery rather than any subjective judgments.

Following the recommendations of the M.Narasimhan committee, the Reserve Bank began publishing guidelines on the concepts of Income Recognition, Asset Classification, and Advance Provisioning. These requirements, which are updated on a regular basis, are commonly referred to as IRAC norms.

The Reserve Bank of India issued guidelines that required banks to identify bad loans, also known as non-performing assets, and barred banks from recognizing interest on a part of the bad loans. Furthermore, it made appropriate protections for these bad loans essential. The provisioning standards were increased to the point of giving a tiny proportion of provision even on Good Loans, allowing the bank to project its genuine financial health and endure bad times.

Basic notion of IRAC Norms

Banks must take the following steps when implementing these guidelines. 

  • Advances are classified as performing or non-performing based on their performance.
  •  Recognize Interest in Advances in Performance If interest has already been accounted for; reverse the interest on non-performing advances. 
  • Begin accounting for the interest on these nonperforming advances only when the money is received.

Make appropriate provisions for performing and nonperforming advances in accordance with the “RBI Guidelines.”

Important amendments to IRAC norms for bank branch auditors

The RBI offered several clarifications in its notice dated November 12, 2021 in order to more precisely interpret the existing IRAC, which we must take in mind while performing branch audits this time. The substance of the same is repeated below, which is highly significant in terms of determining the proper date of classifying various loan accounts as SMA or NPA, further downgrading of NPA accounts, determining the magnitude of interest reversal, and also establishing provision in accordance with norms:

  • Clause A : Date of SMA or NPA categorization Banks were detected not designating accounts as NPA or SMA on the right dates. If an account’s 90th day overdue date happened on, say, March 31st, the account was categorized as NPA on April 1st, under the notion that an account might be classed as NPA if it is more than 90 days late. This gimmick is no longer feasible. The account will become NPA soon after the day-end process for the 90th day is completed. If the overdue position is not cleared before executing the day-end procedure for the 90th day, it will become NPA on the same day as soon as day-end happens.In layman’s terms, the account now becomes SMA on the 30th day evening and NPA on the 90th day evening if the overdue is not cleared by the day end procedure. Similarly, if the due amount is not paid before the running day end procedure on the due date, the account would become overdue. Please keep in mind that this is not a novel provision. It is only a clarification of current IRAC standards. As a result, these conditions will apply to all loan accounts, regardless of SMA or NPA dates.
  • Clause B: ‘Out of order’ definition previously, banks took advantage of a loophole in defining ‘out of order’ in the case of CC/OD services. Banks appropriately checked ‘out of order’ status for situations where credits were insufficient to cover interest charged on daily basis, but only on balance sheet dates for cases where credits were insufficient to cover interest incurred. The system will now have to verify the account every day to see if the credits from the previous 90 days are sufficient to offset the interest incurred during that period. In other words, a CC/OD account might become NPA on any date (not just the closure date) due to insufficient credits in the previous 90 days to satisfy interest debited during that period.
  • Clause C: In the case of term loan interest arrears, NPA status is assigned. Previously, in the case of term loans, an account was categorized as NPA only if the interest due and charged during any quarter was not fully serviced within 90 days of the quarter’s end. For example, interest charged in April, May, and June had to be fully paid by the 28th of September (90 days from the 30th of June) to avoid becoming a non-performing asset (NPA). In this manner, the borrower could delay payment of interest due for the month of April until the 28th of September, a 5 month period that was not in accordance with the IRAC regulations.The same has now been changed. A term loan account will now be categorized as NPA if the interest charged at specified rates is more than 90 days past due. In other words, each amount of interest charged must now be paid separately within 90 days, and interest debited for a calendar quarter cannot be combined. For example, interest charged on April 30th must be paid by July 29th, interest charged on May 31st must be paid in full by August 29th, and interest charged in June must be paid in full by September 28th. As a result, each amount of interest responsibility now has just 90 days to be paid.This revision will be more significant in the case of term loans during principle repayment moratorium when only interest is required to be paid during moratorium and SMA or NPA status is determined for nonpayment of interest alone.
  • Clause D: Only upon complete settlement of arrears can NPA accounts be upgraded. Previously, several lending institutions upgraded NPA accounts to standard on payment of merely a partly overdue sum or simply the interest component (referred to in banking as the ‘critical amount’). It is noted that an NPA account can only be upgraded if all principle and interest arrears are paid in full. In other words, just a crucial amount can be paid to prevent the NPA designation until the account really becomes NPA, but once the account becomes NPA, the total amount of arrears, both principle and interest, must be entirely paid to exit the NPA status. (This clause does not apply to restructured accounts.) There are specific provisions for such situations.)
  • Clause E: Booking of interest income in the case of loans with an interest payment moratorium In the event of loans where a moratorium on interest repayment has been issued, lending institutions may record interest income on an accrual basis for accounts that remain classed as ‘standard,’ even though such interest has not been received by the bank. Furthermore, if loans with a moratorium on interest payments (permitted at the time of loan sanction) become NPA after the moratorium period expires, the capitalized interest corresponding to the interest accrued during the moratorium period does not need to be reversed even if not actually realized.Although these amendments/clarifications were incorporated by RBI in its latest Master Circular on IRAC regulations released on April 1st, 2022, Legal Window have tried to highlighted them separately to draw your attention to their relevance in adhering to IRAC norms when performing branch audits this year.

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The revenue recognition policy should be objective and based on a track record of recovery rather than any subjective judgments. Similarly, the classification of bank assets must be done using objective criteria to guarantee uniform and consistent execution of the regulations. Furthermore, provisioning should be provided on the basis of asset categorization based on the duration for which the asset has been non-performing, as well as the availability of security and its realizable value. Banks are asked to ensure that when making loans and advances, reasonable repayment plans based on cash flows with borrowers are established. This would go a long way toward facilitating early repayment by borrowers and therefore improving the record of advance recovery.

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