Provisioning Norms & IRAC Framework

The IRAC framework (Income Recognition and Asset Classification) is the cornerstone of prudential banking regulation in India. Introduced based on the Narasimham Committee I (1992) recommendations, IRAC norms prescribe how banks should recognise income, classify assets, and make provisions for potential losses. This is one of the most important topics for the JAIIB exam.

Narasimham Committee I (1992) — Committee on Financial System

• Recommended introduction of IRAC norms for all banks
• RBI issued new guidelines in February 1992 on income recognition, asset classification, and provisioning
• Also recommended: capital adequacy norms, progressive reduction of CRR/SLR, deregulation of lending rates, establishment of DRTs

Narasimham Committee II (1998) — Committee on Banking Sector Reforms

• Recommended raising capital adequacy to 9%
• Suggested Narrow Banking for weak banks with high NPAs
• Recommended merger of strong banks
• Advocated greater autonomy for bank management

Standard Assets

• Interest income recognised on accrual basis
• Income booked as it accrues, regardless of receipt

Non-Performing Assets

• Income recognised on cash basis only
• Interest already accrued and credited to income must be reversed
• No interest should be charged and taken to income on NPAs
• Fees and commissions on NPAs also recognised on cash basis only

Key Rules

• If an account is classified as NPA, all facilities to the borrower are treated as NPA (even if some are performing)
• Interest on NPAs recorded in a "Interest Suspense Account" (not in P&L)
• Government-guaranteed advances: Income recognised only on cash basis if guarantee has been invoked and remains unpaid

All bank advances are classified into four categories:

1. Standard Assets

• Loans where borrower is paying regularly
• No concern about repayment
• Does not carry more than normal risk

2. Sub-Standard Assets

• NPA for a period not exceeding 12 months
• Well-defined credit weakness that jeopardises liquidation of the debt
• Possibility of bank sustaining some loss if deficiencies are not corrected

3. Doubtful Assets

• Has been Sub-Standard for more than 12 months
• Collection/liquidation is doubtful and improbable
• Sub-classified by period:

4. Loss Assets

• Identified as uncollectable by bank, auditor, or RBI inspection
• May still remain on the bank's books for technical/legal reasons
• Should be written off or fully provided for

Provisioning means setting aside money from profits to cover potential losses from bad loans.

Provisioning Rates

Important Notes on Provisioning

• Provisioning is made on the outstanding balance, not the overdue amount
• For doubtful assets, provisioning on the secured portion is based on realisable value of security
• The unsecured portion of all doubtful assets requires 100% provisioning
• Loss assets must be written off or 100% provisioned if retained in books

Given: A loan of Rs 10,00,000 classified as Doubtful-1. Security value: Rs 6,00,000.

When a bank modifies the terms of a loan (extends tenure, reduces interest rate, converts debt to equity):

• Restructured standard assets are downgraded to Sub-Standard and remain so for a specified period
• Restructured NPAs continue as NPAs
• Additional provisioning may be required for the diminution in fair value of the advance
• Upgraded only after satisfactory performance under revised terms

PCR = Total Provisions / Gross NPAs x 100

• RBI expects banks to maintain a PCR of at least 70%
• Higher PCR indicates better provisioning and cushion against losses
• Includes specific provisions + floating provisions + write-offs

• RBI allows banks to build a floating provision during good times
• This buffer can be used during periods of economic stress
• Cannot be used for regulatory compliance of specific provisions
• Helps smooth the impact of NPAs across economic cycles

• ECL Framework: RBI is moving towards Expected Credit Loss (ECL) model aligned with Ind AS 109
• Under ECL, provisions will be based on expected future losses, not just incurred losses
• This is a shift from the current incurred loss model to a forward-looking model
• Banks will need to categorise assets into 3 stages based on credit quality deterioration

• IRAC norms introduced based on Narasimham Committee I (1992) recommendations
• Three pillars: Income Recognition (accrual vs cash), Asset Classification (4 categories), Provisioning (% of outstanding)
• NPA = overdue > 90 days (standard rule); Agriculture = 2 crop seasons (short) or 1 crop season (long)
• Asset categories: Standard → Sub-Standard (12 months) → Doubtful (D1/D2/D3) → Loss
• Income on NPAs: Cash basis only — accrued interest must be reversed
• Standard asset provisioning: 0.25% to 1% depending on category
• Sub-Standard: 15% (secured), 25% (unsecured)
• Doubtful unsecured: 100%; Loss assets: 100%
• PCR = Total Provisions / Gross NPAs x 100 — target at least 70%
• Restructured standard assets are downgraded to Sub-Standard
• RBI is moving towards Expected Credit Loss (ECL) framework
• Provisioning is on outstanding balance, not the overdue amount