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Query No. 6
Subject:
Creation of provision for non-fund based facilities.1
A. Facts of the Case
1. A nationalised bank is covered under the Banking Companies
(Acquisition and Transfer of Undertakings) Act, 1970. Its main
function is acceptance of deposits and making advances to various
customers. The querist has stated that during the course of
business, some loan accounts become non-performing and stop
generating income. Prudential norms on Income Recognition, Asset
Classification and Provisioning pertaining to Advances have been
prescribed by the Reserve Bank of India (RBI), being regulator of
banks. The Master Circular issued by RBI, dated 1st July, 2005,
elaborates the provisioning requirements for ‘Fund based accounts’.
However, RBI guidelines are silent with regard to provisioning in
respect of ‘Non-fund based facilities’.
2. The querist has further mentioned that the Master Circular of
the RBI requires reporting on non-performing assets (NPAs) to the
RBI in the following format:
1. Gross advances
2. Gross NPAs
3. Gross NPAs as a percentage of gross advances
4. Total Deductions (i+ii+iii+iv)
(i) Balances in Interest Suspense Account
(ii) DICGC/ECGC claims received and held pending
adjustment
(iii) Part payment received and kept in suspense account
(iv) Total provisions held
5. Net advances (1 – 4)
6. Net NPAs (2 – 4)
7. Net NPAs as a percentage of net advances
For the purpose of the above reporting, ‘gross advances’ mean all
outstanding loans and advances including advances for which
refinance has been received but excluding rediscounted bills, and
advances written off at Head Office level (technical write-off).
3. According to the querist, it is clear from the above that gross
advances to be reported to the RBI only comprise loans and
advances (i.e., funded facilities) and not non-funded facilities. It is
only logical that the NPAs will cover only those facilities which are
included in gross advances.
B. Query
4. In the light of the above circular, the querist has sought the
opinion of the Expert Advisory Committee on the following issues
with regard to Accounting Standard (AS) 29, ‘Provisions, Contingent
Liabilities and Contingent Assets’, issued by the Institute of
Chartered Accountants of India:
(a) In respect of the borrowal accounts (secured by tangible
assets) classified as non-performing assets, where letters
of credit (LCs) and letters of guarantee (LGs) are
outstanding, whether provision is to be made in the
books of the account of the bank, for such outstanding
LCs and LGs, particularly, when the liability in respect
of such LCs/LGs has not been crystallised.
(b) Whether the answer will be different if no tangible
security is held by the bank.
C. Points considered by the Committee
5. The Committee notes that the basic issue raised in the query
relates to whether provision in respect of non-funded exposures,
such as, LCs and LGs is required to be made under the
requirements of AS 29, the borrowal accounts related to which
have been classified as non-performing assets. The Committee,
while expressing its opinion, has considered only this issue and
has not touched upon any other issue arising from the Facts of the
Case.
6. The Committee notes the definition of the term ‘provision’, the
recognition criteria with regard thereto and the definition of the
term ‘contingent liability’ as per AS 29 which are reproduced below:
“A provision is a liability which can be measured only by
using a substantial degree of estimation.”
“14. A provision should be recognised when:
(a) an enterprise has a present obligation as a result
of a past event;
(b) it is probable that an outflow of resources
embodying economic benefits will be required
to settle the obligation; and
(c) a reliable estimate can be made of the amount
of the obligation.
If these conditions are not met, no provision should be
recognised.”
“A contingent liability is:
(a) a possible obligation that arises from past events
and the existence of which will be confirmed
only by the occurrence or non-occurrence of
one or more uncertain future events not wholly
within the control of the enterprise; or
(b) a present obligation that arises from past events
but is not recognised because:
(i) it is not probable that an outflow of
resources embodying economic benefits
will be required to settle the obligation; or
(ii) a reliable estimate of the amount of the
obligation cannot be made.”
The Committee notes from the above that a provision is required
to be made only when the definition of the term ‘provision’ and
recognition criteria in respect thereof as per AS 29 are satisfied. If
these conditions are not satisfied, these items should be disclosed
as contingent liabilities as per the provisions of AS 29.
7. The Committee is of the view that a borrowal account becoming
an NPA, does not necessarily mean that LCs or LGs related to
that borrowal account will also become NPA. Hence, it requires
assessment on case-to-case basis, in the facts and circumstances
of each case and keeping in view the past experience in respect
of such NPAs as to whether a provision is warranted as per the
requirements of AS 29 or a disclosure as contingent liability is
required as discussed above.
D. Opinion
8. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 4 above:
(a) In respect of LCs/LGs which relate to borrowal accounts
(whether secured by tangible assets or not) which are
NPAs, provision is required to be made only when the
conditions as stipulated in AS 29 are satisfied as
discussed in paragraph 7 above. In case the provision
is required to be made on the aforementioned basis,
the realisable value of the security should be adjusted
while determining the amount of provision required to
be made.
(b) With respect to whether provision is required to be made,
the answer will not be different whether or not a tangible
security is held by the bank, although, the amount of
provision required to be made may differ, if no tangible
security is held, as stated in (a) above.
1 Opinion finalised by the Committee on 14.5.2007.
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