The Reserve Bank of India’s clarification accounting of non-performing advances is likely to increase non-banking finance companies’ (NBFCs) non-performing assets (NPAs) by around a third, according to India Ratings (Ind-Ra).

NBFCs would also have to invest in systems and processes to comply with daily stamping requirements.

Ind-Ra noted that NBFCs have asked the RBI to privide a transition period on this requirement.

Limited impact on provisioning

However, the impact on provisioning could be modest, because NBFCs use Ind-AS (Indian Accounting Standards) and higher rated NBFCs have a more conservative provision policy than IRAC (income recognition and asset classification) requirements.

All arrears to be cleared

The credit rating agency observed that the RBI clarification would allow stage 3 (credit impaired) assets to become standard only when all overdues and arrears (including interest) are cleared.

Earlier, NBFCs would classify an account as Stage 3 when there is a payment overdue for more than 90 days. Typically, for monthly payments, this would be when there are 3 or more instalments overdue on any account.

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However, when the borrower makes a part payment such that the total amount due is less than three instalments, the account is removed from NPA classification and classified as a standard asset. It remains in the overdue category if not all dues are cleared.

Now, RBI has restricted movement from Stage 3 to Standard category.

NBFC borrowers are generally a weak class of borrowers and have volatile cash flows so once an account has been classified as NPA, it could remain there for a considerable period, said Pankaj Naik, Associate Director, Ind-Ra.

Accelerated pace of NPA recognition

Referring to an RBI circular requiring daily stamping of accounts instead of a monthly or quarterly one to count the number of overdue days, Ind-Ra opined that this would result in an accelerated pace of NPA recognition for accounts.

“Where there is cash collection, NBFC borrowers typically pay their overdues with some delays. Accounts can now get into NPA category for just a day’s delay in payment and once categorised as NPA will not be able to become standard unless all arrears are cleared.

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“So, in other words, accounts would get categorised as NPAs at a faster pace and would remain sticky in that category for a longer period of time. Both these accounting treatments would result into higher headline number for NBFCs,” said Naik.

He noted that it may so happen that NBFCs would disclose NPA numbers as per IRAC norms and Stage 3 numbers as per Ind-AS separately in their disclosures.

Varied performance across segments

The agency assessed that borrowers in the earn-and-pay model such as commercial vehicle finance, small ticket business loans, and personal loans to self-employed customers are vulnerable with volatile cash flows.

They are generally not in a position to clear all dues in one go and so the headline numbers would look elevated.

On the other hand, home loan and salaried personal loans could exhibit a better performance.