VERIFICATION OF ADVANCES

1. VERIFICATION OF ADVANCES Radhesh L Bhat, FCA

2. TOPICS COVERED • Audit of advances – vis-a-vis recent RBI guidelines – Master Circular/Directions and recent relevant circulars • Practical issues

3. Verification of advances • RBI Master Circular on Income Recognition and Asset Classification dt. 01-07-2015 • From Jan 2016, Master Directions

4. Relevant notifications/circulars issued by RBISINCE April 2018 till date

5. Relevant Circulars of RBI issued in February 2018 • Circular dated 7 February 2018 granting relief for MSME Borrowers registered under GST • Circular dated 12 February 2018 w.r.t. Resolution of Stressed Assets – Revised Framework

6. 7 Feb 2018 Circular - MSME • Circular applies only to borrowers which are classified as micro, small and medium enterprise under the MSMED Act, 2006. • Conditions for relief: • The borrower is registered under the GST as on 31-03-2018 • The aggregate exposure (including non-fund) of banks and NBFCs, does not exceed Rs. 25 crore as on 31.01.2018. • The borrower’s account was standard as on 31 August 2017.

7. 7 Feb 2018 Circular - MSME • The overdue amount as on 01-09-2017 and payments due between 01-09-2017 and 31-01-2018 - paid not later than 180 days from respective original due dates. • Provision of 5% be made against the exposures not classified as NPA (may be reversed as and when no amount is overdue beyond the 90/120day norm) • The additional time is only for asset classification and not for income recognition • if the interest from the borrower is overdue for more than 90/120 days, the same shall not be recognised on accrual basis. Such accounts shall continue to be classified as Standard.

8. 7 Feb 2018 Circular - MSME Aggregate Exposure As per RBI Master Circular on Exposure Norms dated 1 July 2015 - Exposure: include credit exposure (funded and non-funded credit limits) and investment exposure (including underwriting and similar commitments). The sanctioned limits or outstanding, whichever are higher, shall be reckoned for arriving at the exposure limit. However, in the case of fully drawn term loans, where there is no scope for redrawal of any portion of the sanctioned limit, banks may reckon the outstanding as the exposure.

9. Circular - RBI/2017-18/186 dt 06.06.2018 – formalisation of MSMEs Purpose:Temporarily allow banks to classify their exposure to MSMEs as per 180 days past due criterion (registered under GST or not) as Standard – subject to conditions: • Aggregate exposure (incl. NF based facilities) to banks does not exceed Rs.25 crores as on 31-05-18 • Account was standard on 31-08-17 • Dues as on 01-09-17 and falling due up to 31-12-18 were/are paid not later than 180 days from the original due date • For GST regd. MSMES, 180 days past due criterion to be aligned to extant IRAC norms in phased manner as given below—

10. Those not GST regd. as on 31-12-18, asset classification in respect of dues payable from 01-01-2019 onwards shall immediately revert to the extant IRAC norms • Other terms & conditions dt. 07-02-2018 remain unchanged

11. RBI/2018-19/100, dt. 01-01-2019 – MSME restructuring One time restructuring of existing loans to MSME, classified as STD without downgrade in asset classification, subject to conditions: • Aggregate exposure (incl. NF based facilities) to banks does not exceed Rs.25 crores as on 01-01-19 • Account is default but STD as on 01-01-19 and continues as STD till implementation of restructuring • Regd. under GST on the date of implementation (except for MSMES exempt from regn. under GST)* • Restructuring to be implemented on or before 31-03-2020, by fulfilling conditions *Clarified by Circular dt. 22-02-2019 -- exemption limit obtained as on 01-01-19

12. Additional provision of 5% (can be reversed at the end of the ‘specified period’ * on satisfactory performance) – • Post restructuring, normal IRAC norms to apply for NPA classification • Appropriate disclosure in Bank’s Notes to Accounts • Other instructions as earlier for MSME to apply • Banks to place the policy (including framework for viability assessment/monitoring) for this purpose before their Board within a month. • NPA, on restructuring, cannot be ungraded. For such cases, extant IRAC norms apply. *Specified period means the period from the date of implementation of RP up to the date by which at least 20 percent of the outstanding principal debt as per the RP and interest capitalisation sanctioned as part of the restructuring, if any, is repaid. Provided that the specified period cannot end before one year from the commencement of the first payment of interest or principal (whichever is later) on the credit facility with longest period of moratorium under the terms of RP.

13. RBI/2018-19/129, dt. 22-02-2019 – Interest subvention Purpose: To encourage both manufacturing and service sector to increase productivity and provides incentives to MSMES on boarding on GST platform • Scheme to be operational for FY 2019 and 2020 • MSMES to have (i) Udyog Aadhar No (UAN) and (ii) GSTN • Incremental TL or fresh TL or incremental or fresh working capital extended during the period from 02-11-2018 and next FY would be covered • All working capital or TL would be eligible for coverage to the extent of Rs.1 crore only during the period of the scheme • MSME exporters availing interest subvention for pre/post shipment credit and MSMEs availing any other subvention schemes will not be eligible under this scheme

14. RBI/2018-19/137, dt. 07-03-2019 – Interest subvention for short term crop loans • Years covered – 2018-19 and 2019-20 • For Short term crop loans up to Rs.3 lakhs, subject to conditions

15. notification dt 19.06.2018 Priority sector lending – enhanced limit • The housing loan limits for eligibility under priority sector lending revised to ₹ 35 lakh (earlier Rs.28 Lakhs) in metropolitan centres (with population of ten lakh and above) and ₹ 25 lakh (earlier Rs.20 lakhs) in other centres, • provided the overall cost of the dwelling unit in the metropolitan centre and at other centres does not exceed ₹ 45 lakh (earlier Rs.35 lakhs) and ₹ 30 lakh (earlier Rs.25 lakhs) , respectively Purpose: To bring convergence of the Priority Sector Lending guidelines for housing loans with the Affordable Housing Scheme & to give a fillip to low-cost housing for the Economically Weaker Sections and Low Income Groups

16. 12th Feb 2018 CircularResolution of stressed Assets

17. 12 Feb 2018 CircularResolution of stressed Assets In view of the enactment of the Insolvency and Bankruptcy Code, 2016 (IBC), it has been decided to substitute the existing guidelines with a harmonised and simplified generic framework for resolution of stressed assets. • Early Identification and reporting of stress Lenders to identify incipient stress in loan accounts immediately on default by classifying stress assets as SMA • Resolution Plan (RP) – Large accounts* All lenders must put in place Board approved policies for resolution of stressed assets under this framework, including the timelines for resolution. *Aggregate exposure of lenders is Rs. 100 cr and above

18. Default defined… • Term loan: non-payment of debt when whole or any part or instalment of the amount of debt has become due and payable and is not repaid by the debtor or the corporate debtor, as the case may be. • Revolving facilities like cash credit: Default also means – without prejudice to the above – the outstanding balance remaining continuously in excess of the sanctioned limit/DP (whichever is lower) for more than 30 days.

19. Early detection – Special Mention Account (SMA) Mandatory Reporting requirements on Banks • Banks to report the credit information including classification of an account as SMA to Central Repository of information on large credits of RBI (CRILC) – aggregate exposure of Rs.5 cr & above – on monthly basis (w.e.f 01-04-2018) • Every Friday to report on defaults (aggregate exposure > Rs.5 cr,)

20. 12 FEB 2018 Circular Implementation Conditions for RP An RP in respect of borrower entities to whom the lenders continue to have credit exposure, shall be deemed to be ‘implemented’ only if the following conditions are met: • The borrower entity is no longer in default with any of the lenders; • If the resolution involves restructuring, then • All related documentation, including execution of necessary agreements between lenders and borrower / creation of security charge / perfection of securities are completed by all lenders; and • the new capital structure and/or changes in the terms of conditions of the existing loans get duly reflected in the books of all the lenders and the borrower.

21. 12 Feb 2018 Circular The following extant instructions on resolution of stressed assets stands withdrawn: • Framework for Revitalising Distressed Assets, • Corporate Debt Restructuring Scheme, • Flexible Structuring of Existing Long Term Project Loans, • Strategic Debt Restructuring Scheme (SDR), • Change in Ownership outside SDR, and • Scheme for Sustainable Structuring of Stressed Assets (S4A) • Joint Lenders’ Forum (JLF) as an institutional mechanism for resolution of stressed accounts also stands discontinued. All accounts, including such accounts where any of the schemes have been invoked, but not yet implemented, shall be governed by the revised framework.

22. 12 Feb 2018 CircularNorms for restructuring Conditions for Upgrade Standard accounts classified as NPA and NPA accounts retained in the same category on restructuring by the lenders may be upgraded only when all the outstanding loan / facilities in the account demonstrate ‘satisfactory performance’ during the ‘specified period’ . • Satisfactory performance: the payments in respect of borrower entity are not in default at any point of time. • Specified period means the period from the date of implementation of RP up to the date by which at least 20 percent of the outstanding principal debt as per the RP and interest capitalisation sanctioned as part of the restructuring, if any, is repaid. • Provided that the specified period cannot end before one year from the commencement of the first payment of interest or principal (whichever is later) on the credit facility with longest period of moratorium under the terms of RP.

23. Exceptions to 12-02-18 circular (RP) • Revival and rehabilitation of MSME (still governed by 17-03-2016 circular) – modified vide Circular dt. 06-06-18 and 01-01-2019 • Restructuring in the event of natural calamities (still covered by Master directions -2017-18) • Fraud/wilful default cases – ineligible for restructuring • Restructuring involving deferment of DCCO – earlier instructions

24. MASTER CIRCULAR Dt. 01-07-2015

25. IRAC Norms for asset classification • Term Loan: • Interest/principal overdue for more than 90 days • As per Para 2.1.3, only if interest due and charged during any quarter is not serviced fully within 90 days from the end of the quarter. • CC/OD “Out of Order”: • Outstanding balance greater than DP/Limit (whichever is lower) for 90 days. • In case where outstanding balance in the principal operating account is less than the limit/Dp, but No credits for 90 days, or credits not sufficient to cover the interest debits during the period. • “Overdue’ - if not paid within the due date.

26. NPA Norms – IRAC • Bills Purchased/Discounted: Overdue for more than 90 days • Agricultural Advances: • Long duration crop loans: Overdue for 1 crop season • Short duration crop loans: Overdue for 2 crop season “long duration” crops would be crops with crop season longer than one year and crops, which are not “long duration” crops, would be treated as “short duration” crops. The crop season for each crop, which means the period up to harvesting of the crops raised, would be as determined by the State Level Bankers’ Committee in each State. • Credit Card: Minimum amount not paid within 90 days

27. 90 days norms – PRACTICAL issues • Date from which 90 days norms applies ? • Overdue: • Internal guidelines of 1 week/1 month not applicable. • Out of order: • Beware of reversal entries (Intra day credits)– mistaken as credits. To see day end balance • Beware of solitary credits • Credits from other accounts/other branches to regularise the account – Genuineness • Continuously in excess, except for a few days at the end – AUDIT MAY REPORT • Check SMA reports

28. 90 days norms – PRACTICAL issues - Instruments Bills purchased/discounted: • Check on random whether bills are genuine bills (not accommodation bills) – w.r.to underlying documents • Check Overdue bills vis a vis reclassification based on norms • Extension of due date vis-a-vis restructuring • Beware of year-end regularisation by cheque purchase • Packing credits – extension permitted within 90 days norms up to 360 days (To obtain letter from foreign buyer seeking extension of delivery of goods)

29. 90 days norms – PRACTICAL issues - Stock • Stock statements – should not be older than 3 months. • If older than 3 months, irregular - hence maximum age can be 6 months • Stock must be paid stock • Non moving stock/debtors > 6 months • Comparison with PY end stock statement vis-a-vis financials – wide variation? • Stock audit – comments, if any • Branch Auditor to Do Physical verification of stressed borrowers cases • Bank’s policy of computation of stock value for MPBF

30. Practical issues with stock statements • Delay in submission • Lumpsum details given without quantitative details • Ageing Stock and Debtors • Sundry creditors not reduced • No stock audit report even when mandated • Branch response not satisfactory • No branch inspection • Segregation of debts more than 90 days not done • Repetitive debts • Comparison with turnover (Ratio analysis)

31. Computationof Drawing power • Level of DP as per MPBF method to be reassessed by the Bank periodically. • Consortium Advances: Bank to determine DP based on its own sanction terms and not as per DP allocated by them. • Beware of cases of wrong computation of bank’s DP

32. DISCREPANCIES IN COMPUTATION OF DP

33. DP computation – MPBF Method Illustration

34. Drawing power Illustration – MPBF Method

35. Cash credit accounts – practical issues • Sales proceeds not fully routed through the account (credit summation) • Stock statement is not seen an authenticated one • Stock statement/bank’s share in consortium not obtained on time by branch • No proper system in bank to monitor receipt of stock statement/insurance renewal • Circuitry transactions, involving same borrower account or borrower in the same group • Greening of bad accounts - Facilities of borrower seen closed and on the same day fresh credit facilities were granted, by routing the proceeds through RTGS vide another Bank

36. AGRICULTURAL ADVANCES Irregular operations in accounts and diversion of funds • Verify whether agricultural proceeds and operations are routed through the account. • The borrowers were not remitting amounts in the account depending on the crop produce. Amounts are seen remitted at the period end only to regularize the account. • Check whether the loans were used for the purpose for which they were granted. • Check whether Proper inspection is carried out. • Check whether any Loans granted for purchase of land wrongly classified as Agricultural advance.

37. 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 • Non submission of stock statements/financials on time • Borrower services interest after repeated reminders/persuasions • Submitted stock statements are not proper and mismatch between audited figures • Bullet loans remain unpaid • Undue delay in commence of projects • Funded/unfunded limits not commensurate with operations • Bills discounting disproportionate to operations (accommodation)

38. NPA CLASSIFICATION NORMS

39. CLASSIFICATION OF NPAs • Sub Standard- NPA for a period of < 12 months • Doubtful- NPA for a period of > 12 months • within D - d1, d2, d3 (for provisioning) • Loss Assets- Identified as such by Bank or internal or external auditors or the RBI inspection • Issue: • Whether captured by the CBS correctly • Whether downgrading is done correctly • Whether upgrading done is correct

40. Provisioning norms – certain Important aspects • Where there is erosion in value of security/fraud -straightaway reclassify into- - Where erosion > 50% - Doubtful - Where realizable value less than 10% - Loss assets (50% /10% - based on value assessed by the bank or accepted by RBI at the time of last inspection) • Valuation for NPA to be done once in 3 years. • For NPAs with balances greater than Rs.5 crores, stock audit by external agency.

41. Verification of non funded advances Letter of credit: • In the Form Bank Guarantee • Promise by bank to pay in case of default by buyer • Letter of Undertaking and Letter of Comfort – done away with vide RBI A.P. (DIR Series) Circular No. 20, dt 13-03-2018 - discontinued the practice of issuance of Letter of Undertaking/Letter of Comforts for Trade Credits for imports into India by AD Category–I banks) • LC and BG for Trade Credits for imports into India continue to be issued subject to compliance with the provisions contained in Department of Banking Regulation Master Circular No. DBR. No. Dir. BC.11/13.03.00/2015-16 dated July 1, 2015 on “Guarantees and Co-acceptances”, as amended from time to time.

42. NPA classification – certain Important aspects • Classification based on record of recovery (not based on Security or Net Worth) • Additional provision can be made by Bank • NPA considered borrower wise and not facility wise • For consortium, record of recovery at Bank being audited to be considered • For working capital, DP calculated from Stock statement older than 3 months to be considered irregular • Technically NPA – regularised subsequent to balance sheet date - See the health of the account & apply professional judgement

43. Practical issues – general • Non-compliance/delay in compliance of terms of sanction • End use of loan proceeds – diversion of funds • Frequent rollovers/extension of export credit • Improper credit supervision and monitoring (e.g. branch not doing field inspection on time) Frequent ad hoc facilities • Persisting audit comments by RBI/internal inspection on branch advances, indicating bad appraisal • Lack of transparency of information & Prima facie unacceptable explanations • Branch’s Dependence on 1 or 2 key borrowers

44. Take over loans – NPA norms • Existing classification to be retained • 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

45. PROVISIONING NORMS

46. NPA norms – for regular accounts • if not renewed/reviewed within 180 days from due date • Ad hoc limit if not renewed/reviewed within 180 days from due date Even a performing good account to be downgraded

47. ACCELERATED PROVISION –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 • evergreening the account. Refer para 31 of MC – July 2015 for accelerated rates.

48. Project loans – prudential norms

49. Project loans • Key word –DCCO (Date of Commencement of Commercial Operations) • Refer detailed sanction proposal to identify DCCO • To classify as NPA if commercial operations not commenced on DCCO agreed – irrespective of good track record of repayment/ existence of security • Exception provided:

50. Restructuring • Refers to change in any terms and conditions • Downgraded immediately on restricting (exceptions – deferment of DCCO) • Relaxations applicable only to Infra sector (refer para 4.2.15.3 of July 2015) • Restructuring – meaning expanded • “FINANCIAL DIFFICULTY” - expanded (circular dt. 12-02-2018 on Resolution plan)