Accounting and Auditing Update - June 2022

CHAPTER 3

Non-performing assets
and Provisioning
This article aims to:
Explicate the regulations pertaining to provisioning of assets in
the financial statements and as per the regulatory requirements,
and disclosures thereon.

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Accounting and Auditing Update - June 2022

Background
As per the regulations issued by RBI, provisioning The RBI, vide the SBR has prescribed certain additional regulations pertaining to provisioning and In this article, we aim to provide an
of assets is critical for all entities in the financial disclosures of provisions for certain layers of the NBFCs, as given in figure 1 below: overview of the current requirements
services sector. Currently, the SI-NBFC Master pertaining to NPA classification and
Directions1, NSI-NBFC Master Directions2 and HFC provisioning under the RBI regulations
Figure 1: Additional regulations pertaining to provisioning issued under SBR and under the Ind AS and explicate the
Master Directions3 (collectively termed as Master
Directions) provide norms for asset classification amendments issued under the SBR.
and provisioning for NBFCs. As per the Master
NPA Standard asset Additional
Directions every NBFC shall, after considering the
degree of well-defined credit weaknesses and classification provisioning disclosures
extent of dependence on collateral security for
realisation, classify its lease/hire purchase assets, • Harmonised NPA • Differential provisioning • Disclosure of divergence
loans and advances and any other forms of credit classification norms for towards different classes in asset classification
into the following classes, namely: all NBFCs to 90 days of standard assets and provisioning above a
certain threshold
(i) Standard assets; • Applicable to NBFCs in • Applicable to NBFCs in
the base layer the upper layer • Applicable to NBFCs in
(ii) Sub-standard assets; the middle and upper
• Guidelines are effective • Guidelines are effective
(iii) Doubtful assets; and layer
from 1 October 2022 from 1 October 2022
(iv) Loss assets. • Applicable for financial
statements for the year
Provisioning is required for each of these assets at ending 31 March 2023
the rates prescribed by RBI. Additionally, NBFCs are
required to disclose provisions made as per the RBI
regulations in their financial statements.
1. Master Direction - Non-Banking Financial Company -
(Source: KPMG in India’s analysis,2022, read with RBI circulars, Scale Based Regulation (SBR): A Revised Regulatory Framework Systemically Important Non-Deposit taking Company and
for NBFCs issued on 22 October 2021, Disclosure in Financial Statements- Notes to Account issued on 19 April 2022 and Deposit taking Company (Reserve Bank) Directions, 2016.
Provisioning for Standard assets by Non-Banking Financial Company – Upper Layer, issued on 6 June 2022) 2. Master Direction - Non-Banking Financial Company –
Non-Systemically Important Non-Deposit taking Company
(Reserve Bank) Directions, 2016.
3. Master Direction – Non-Banking Financial Company –
Housing Finance Company (Reserve Bank) Directions, 2021.

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Accounting and Auditing Update - June 2022

Non-Performing Assets (NPA)

classification Clarifications issued by RBI on NPA classifications
Currently, the NBFCs-ND with an asset size of less On 1 October 2021, RBI issued a Master However, references to ‘90 days’ for
than INR500 crore (i.e. non-systemically important, Circular on Prudential Norms on Income SMA-2/NPA classification may be read as
non-deposit taking NBFCs) classify assets with Recognition Asset Classification and per the NPA norms applicable to NBFC-ND
an overdue period of more than 180 days as NPA Provisioning (IRACP) which is applicable to (non-systemically important, non-deposit
(NPA norm). All other NBFCs have an NPA norm all commercial banks (excluding regional rural taking NBFCs).
of 90 days. banks). Subsequently, on 12 November 2021
• Upgradation of accounts classified
and 15 February 2022, RBI issued circulars
The RBI has now harmonised the NPA norms for all as NPAs: The IRACP norms state that
providing certain clarifications on IRACP norms
NBFCs to 90 days. This amendment will impact the accounts classified as NPA can be upgraded
to ensure uniformity in its implementation and
NBFCs in the base layer, which includes the NBFC- to ‘standard account’ category if arrears
harmonising certain requirements for all lending
ND (i.e. the non-systemically important, non-deposit of interest and principal are paid by the
institutions4. Some clarifications that will impact
taking NBFCs). Accordingly, a glide path has been borrower. RBI observed that many lending
NPA classification for NBFCs with effect from
provided to NBFCs in the base layer to adhere to institutions upgrade NPA accounts to
1 October 2022 include:
the 90 days NPA norm, as given below: ‘standard’ category upon payment of only
• SMA classification applicable to NBFC- interest overdues, partial overdues, etc.
ND: Currently, the requirement to classify
The RBI clarified that loan accounts
NPA norm Timeline overdue borrower accounts as SMA as
classified as NPAs may be upgraded as
prescribed in the ‘Prudential Framework
‘standard’ asset only if entire arrears
for Resolution of Stressed Assets’ is
of interest and principal are paid by the
applicable to NBFC-ND-SI and NBFC-D
borrower. Circular dated 15 February 2022
> 150 days By 31 March 2024 (i.e. all systemically important, non-deposit
has provided NBFCs time till 30 September
taking NBFCs and all deposit taking NBFCs),
2022 to put in place the necessary systems
however, it is not applicable to NBFC-ND
to implement this.
(i.e. non-systemically important, non-deposit
> 120 days By 31 March 2025 taking NBFCs).
With the clarifications issued by RBI, these
provisions will now apply even to NBFC-ND.

> 90 days By 31 March 2026

4. This includes all commercial banks, co-operative banks, All-India Financial Institutions and all NBFCs (including HFCs).

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Accounting and Auditing Update - June 2022

Provisioning requirements and computation of a prudential floor

While dealing with provisioning for assets, financial statements to provide a benchmark to B. Expected credit losses (ECL) Ind AS 109 also provides a rebuttable
NBFCs should look at two aspects i.e. the their BoD, RBI supervisors and other stakeholders, presumption, wherein the credit risk of a
The impairment model in Ind AS 109 is an
regulatory aspect and the accounting aspect. on the adequacy of provisioning for credit losses. financial asset is presumed to have increased
expected credit loss model, which means that
The Master Directions instruct NBFCs that are significantly since initial recognition when
Where impairment allowance under Ind AS 109 it is not necessary for a loss event to occur
required to implement Ind AS to prepare their contractual payments are more than 30 days
(which is recorded in the financial statements) before an impairment loss is recognised. As a
financial statements in accordance with the past due. An entity can rebut this presumption
is lower than the provisioning required under result,all financial assets generally carry a loss
principles enunciated in Ind AS. NBFCs that are not if the entity has reasonable and supportable
IRACP (including standard asset provisioning), allowance, however, there are some exceptions
required to adopt Ind AS, should comply with the information that is available without undue
NBFCs/ARCs should appropriate the difference from recognising a loss allowance. ECLs are a
requirements of the notified Accounting Standards cost or effort, that demonstrates that the
from their net profit or loss after tax to a separate probability-weighted estimate of credit losses –
(AS) insofar as they are not inconsistent with the credit risk has not increased significantly since
‘Impairment Reserve’. i.e. the present value of cash shortfalls over the
Master Directions. initial recognition even though the contractual
expected life of the financial instrument. A cash
Some of the key requirements prescribed by Ind payments are more than 30 days past due.
It is expected that most NBFCs in the middle and shortfall is the difference between the cash
AS and the provisioning requirements applicable to
upper layer of the SBR will have a net worth of flows that are due to an entity in accordance Default
NBFCs are discussed below.
INR250 crore or more, hence they would be within with the contract and the cash flows that the
Ind AS 109 does not define the term ‘default’,
the purview of Ind AS. Such NBFCs would need entity expects to receive. Because ECL consider
Accounting as per Ind AS but instead requires each entity to do so. The
to refer to the principles of Ind AS 109, Financial the amount and timing of payments, a credit
definition has to be consistent with that used
Instruments while provisioning for assets in the Requirements of Ind AS 109 with regard to loss arises even if the entity expects to be paid
for internal credit risk management purposes
financial statements. provisioning of assets is given below: in full but later than when contractually due.
for the relevant financial instrument and
In parallel NBFCs/Asset Reconstruction Companies A. Classification and measurement of financial Significant increases in credit risk has to consider qualitative indicators - e.g.
(ARCs) should also maintain the asset classification assets breaches of covenants - when appropriate.
and compute provisions as per extant prudential Entities should initially recognise a 12-month The definition of default is applied consistently,
An entity should classify financial assets as ECL on all financial assets, and subsequently,
norms on Income Recognition, Asset Classification unless information that becomes available
subsequently measured at amortised cost, on every reporting date test whether there
and Provisioning (IRACP) including borrower/ indicates that another default definition is more
Fair Value through Other Comprehensive has been a significant increase in credit risk
beneficiary wise classification, provisioning for appropriate for a particular financial instrument.
Income (FVOCI) or at Fair Value Through of that asset, in which case, a lifetime ECL is
standard as well as restructured assets, NPA
Profit or loss (FVTPL) on the basis of both: recognised on such asset. There is a rebuttable presumption that default
ageing, etc. (termed as Prudential floor)5. A
does not occur later than when a financial
comparison between provisions required under - The business model for managing the Generally, for assessing whether there has asset is 90 days past due unless an entity has
IRACP and impairment allowances made under financial assets; and been a significant increase in credit risk, entities reasonable and supportable information to
Ind AS 109 should be disclosed in the prescribed - The contractual cash flow characteristics compare the probability of defaults on the corroborate a more lagging default criterion.
format by NBFCs/ARCs in the notes to their of the financial assets financial asset at the reporting date with the
probability of default on the financial asset at the
date of initial recognition.
5. This is in accordance with RBI circular dated 13 March 2020 on ‘Implementation of Indian Accounting Standards’

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Accounting and Auditing Update - June 2022

Provisioning requirements under the Master Directions Amendments issued by the scale based regulations (effective 1 October 2022)
The Master Directions prescribe the provisioning requirements for standard assets, sub-standard assets, The RBI has issued detailed guidelines for NBFCs falling in the upper layer of SBR to adopt ‘differential
loss assets and doubtful assets for NBFCs and HFCs as given below: standard asset provisioning norms’7 while computing the provisions on standard assets. These norms
are in line with those prescribed for banks:
Asset classification6 Provisioning for NBFCs Provisioning for HFCs

Loss assets Entire asset to be written off Entire asset to be written off Category of standard assets Rate of provision on standard assets
Or Or Individual housing loans and loans to 0.25 per cent
100 per cent provision on outstanding 100 per cent provision on outstanding Small and Micro Enterprises (SMEs)8
amount amount
Housing loans extended at teaser rates9 2 per cent, which will decreae to 0.4 per cent after one year from the
Doubtful assets A. Unsecured portion A. Unsecured portion
date on which the rates are reset at higher rates (if accounts remain
100 per cent provision 100 per cent provision standard)
B. Secured portion B. Secured portion Advances to Commercial Real Estate10 – 0.75 per cent
20 per cent to 50 per cent provision on 25 per cent to 100 per cent provision Residential Housing (CRE-RH)11 sector
the basis of period for which asset is on the basis of period for which asset is
considered doubtful considered doubtful Advances to Commercial Real Estate 1 per cent
(CRE) sector (other than CRE-RH)
Sub-standard assets Provision of 10 per cent on outstanding Provision of 15 per cent on outstanding
amount amount Restructured advances As stipulated in the applicable prudential norms for resturcturing of
advances
Standard assets A. For all NBFCs MFI and IFC and for Differential standard asset provisioning
Factors with asset size less than INR500 based on category of assets. All other loans and advances not included 0.4 per cent
crore above, including loans to Medium
Enterprises8
0.25 per cent of standard asset
B. For other NBFCs, including Factors (Source: RBI circular, Provisioning for Standard assets by Non-Banking Financial Company – Upper Layer, issued on 6 June 2022)
with asset size greater than INR500 crore
7. Detailed guidelines on differential standard asset provisioning have been issued vide circular dated 6 June 2022.
0.4 per cent of standard asset 8. Definition of the terms Micro Enterprises, Small Enterprises, and Medium Enterprises shall be as per the circular FIDD.MSME & NFS.BC.No.3/06.02.31/2020-21
(This provision has been amended for dated July 2, 2020 on ‘Credit flow to Micro, Small and Medium Enterprises Sector’ as updated from time to time.
NBFCs in the upper layer of the SBR 9. Housing loans extended at teaser rates shall mean housing loans having comparatively lower rates of interest in the first few years after which the rates of interest
are reset at higher rates.
framework, see the section below.)
10. Commercial Real Estate (CRE) would consist of loans to builders/ developers/ others for creation/acquisition of commercial real estate (such as office building,
retail space, multi-purpose commercial premises, multi- tenanted commercial premises, industrial or warehouse space, hotels, land acquisition, development and
(Source: KPMG in India’s analysis, 2022 read with SI-NBFC-Master Directions, NSI-NBFC-Master Directions and HFC-Master construction etc.) where the prospects for repayment, or recovery in case of default, would depend primarily on the cash flows generated by the asset by way of
Directions) lease/rental payments, sale etc. Further, loans for third dwelling unit onwards to an individual will be treated as CRE exposure.
11. Commercial Real Estate – Residential Housing (CRE–RH) is a sub-category of CRE that consist of loans to builders/ developers for residential housing projects
(except for captive consumption). Such projects should ordinarily not include non-residential commercial real estate. However integrated housing project
comprising of some commercial spaces (e.g. shopping complex, school etc.) can also be specified under CRE-RH, provided that the commercial area in
6. Additional rates and provisions have been given for lease and hire purchase assets. These are not covered in this article the residential housing project does not exceed 10 per cent of the total Floor Space Index (FSI) of the project. In case the FSI of the commercial area in the
predominantly residential housing complex exceed the ceiling of 10 per cent, the entire loan should be classified as CRE and not CRE-RH.

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Accounting and Auditing Update - June 2022

Further, current credit exposures12 arising on Additional disclosure requirements

account of the permitted derivative transacitons
would also attract provisioning requirement as Currently, the Master Directions prescribe the NBFCs, by following the RBI regulations, and those Bank (NHB) in the case of Housing Finance
applicable to the loan assets in the ‘standard’ disclosure requirements pertaining to asset computed by RBI (as part of its evaluation of the Companies) exceeds five per cent of the
category, of the concerned counterparties. classification and provisioning, which includes an NBFC’s asset classification and provision for assets reported profits before tax and impairment
All conditions applicable for treatment of the analysis of the NPAs and comparison of provisions computation). The disclosure of divergence in asset loss on financial instruments for the reference
provisions for standard assets would also apply computed as per Ind AS and with the provisions classification and provisioning is required to be period, or
to the aforesaid provisions for permitted computed in accordance with RBI regulations provided in accordance with the format (table 1) as
• The additional Gross NPAs identified by RBI/
derivative transactions. (this is for NBFCs that have adopted Ind AS)13. given below. Disclosures of divergence would be
NHB exceeds five per cent of the reported
required if either or both of the following conditions
Since these provisions are in line with the existing In addition to the existing requirements, the SBR Gross NPAs for the reference period
are satisfied:
provisions pertainig to differential standard asset requires NBFCs in the middle and upper layer to
provisioning applicable to HFCs, the HFCs that disclose divergences in asset classification and • The additional provisioning requirements
are classified in the upper layer of the SBR will provisioning between those computed by the assessed by RBI (or National Housing
not be impacted by this amendment.
Table 1: Format for reporting divergence in asset classification and provisioning
It is to be noted, these revised provisions will be
applied while computing the prudential floor with Sr. Particulars Amount
effect from 1 October 2022. 1 Gross NPAs as on March 31, 20XX* as reported by the NBFC
2 Gross NPAs as on March 31, 20XX as assessed by the Reserve Bank of India/ NHB
3 Divergence in Gross NPAs (2-1)
4 Net NPAs as on March 31, 20XX as reported by the NBFC
5 Net NPAs as on March 31, 20XX as assessed by Reserve Bank of India/ NHB
6 Divergence in Net NPAs (5-4)
7 Provisions for NPAs as on March 31, 20XX as reported by the NBFC

8 Provisions for NPAs as on March 31, 20XX as assessed by Reserve Bank of India/ NHB
9 Divergence in provisioning (8-7)
12. Current credit exposure is defined as the sum of the gross positive
mark-to-market value of all derivative contracts with respect to a single
counterparty, without adjusting against any negative marked-to-market 10 Reported Profit before tax and impairment loss on financial instruments for the year ended March 31, 20XX
values of contracts with the same counterparty.
13. NBFCs that are preparing financial statements as per Ind AS would 11 Reported Net Profit after Tax (PAT) for the year ended March 31, 20XX
additionally be required to provide disclosures prescribed in Ind AS 107,
Financial Statements: Disclosures 12 Adjusted (notional) Net Profit after Tax (PAT) for the year ended March 31, 20XX after considering the divergence in provisioning
* March 31, 20XX is the close of the reference period in respect of which divergences were assessed
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