NPA Classification: How an Account Becomes an NPA

“I paid two lakh last month, so the account cannot be an NPA.” Some version of that sentence comes up in nearly every first meeting about a recall notice. It is wrong, and understanding why is most of what a borrower needs to know about NPA classification.

An account becomes a non-performing asset by an arithmetic test applied by the bank’s system, not by a decision anyone takes about the borrower. For a term loan the test is short: if interest or an instalment of principal remains overdue for more than 90 days, the account is an NPA. A payment made after those 90 days have run does not undo it. Under the rules as they now stand, an NPA is upgraded back to standard only when the entire arrears of interest and principal are cleared. A part payment, however large, does not restore the account.

These rules come from the Reserve Bank’s Master Circular on Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances, usually shortened to the IRACP norms. They are not negotiable at branch level, and that cuts both ways. A bank cannot classify early to build pressure, and a manager cannot hold classification back as a favour.

What “overdue” means, and when the clock is read

Any amount due to the bank under any credit facility is overdue if it is not paid on the due date fixed by the bank. Not the date the bank noticed. Not the date a reminder was sent. The due date in the sanction letter and repayment schedule.

Since the Reserve Bank’s 2021 clarifications, classification into special mention and non-performing categories is carried out as part of the day end process on the relevant calendar date. That is why the NPA date is a specific day and can be stated as one. If a lender cannot tell you the exact date, that is worth noting.

Ninety days also means ninety calendar days, not three months. An instalment due on 5 January that goes unpaid produces an NPA date in early April, and which day in April it lands on can decide whether a notice issued a week later was valid.

NPA classification changes with the facility

Facility	Becomes an NPA when
Term loan	Interest or a principal instalment is overdue for more than 90 days
Cash credit or overdraft	The account remains “out of order” for more than 90 days
Bills purchased or discounted	The bill remains overdue for more than 90 days
Short duration crop loan	Principal or interest is overdue for two crop seasons
Long duration crop loan	Principal or interest is overdue for one crop season

The cash credit test is the one that catches businesses out, because nothing has to bounce for it to bite. An account is out of order in any of these situations:

• The outstanding balance stays continuously above the sanctioned limit or drawing power.
• The outstanding is within the limit, but there are no credits in the account continuously for the period.
• There are credits, but they are not enough to cover the interest debited during the same period.

Each of these is now assessed on a continuous 90 day basis. The trap sits in drawing power. If stock statements stop being submitted, the bank reduces drawing power, and an account that looks perfectly normal to the proprietor is suddenly running above its drawing power every day. Nobody sends a warning letter. The system simply counts.

SMA: the warning stage before an NPA

Before an account turns non-performing it passes through the special mention account categories. These are early warning labels, and they are visible to the lender long before anything is recalled.

Category	Loans other than revolving facilities	Cash credit and overdraft
SMA-0	Overdue up to 30 days	Not applicable
SMA-1	Overdue 31 to 60 days	Out of order for 31 to 60 days
SMA-2	Overdue 61 to 90 days	Out of order for 61 to 90 days

Large exposures are also reported to the Central Repository of Information on Large Credits, which is how other lenders learn about stress in an account before the borrower tells them. An SMA-2 tag is the last useful window for a restructuring conversation. After the ninetieth day the discussion changes completely, because the bank’s own provisioning obligations begin.

After classification: substandard, doubtful, loss

An NPA does not stay in one place. It slides, and each step raises the provision the bank must make against it.

• Substandard. An account that has been an NPA for 12 months or less.
• Doubtful. An account that remained substandard for 12 months. It is then sub-classified by how long it has been doubtful: up to one year, one to three years, and more than three years.
• Loss. An account where loss has been identified by the bank, its auditors or an RBI inspection, but the amount has not been written off.

This matters commercially, not just technically. As the provision rises, the bank has already absorbed the hit in its books, which changes what it can accept in a compromise. Settlement conversations that were impossible in the substandard stage sometimes become possible later. Equally, the borrower’s own position deteriorates as the credit record ages.

Classification is borrower-wise, not facility-wise

This surprises people more than anything else on the list. Asset classification is done for the borrower, not for each loan separately, subject to narrow exceptions. So a company with a perfectly regular term loan and one irregular cash credit will find both classified as NPA. The regular repayments on the term loan do not protect it.

The practical consequence is that a business cannot ringfence its good facility by servicing it while letting another slip. The whole relationship goes together, and so does the credit reporting.

Why the exact date matters more than the label

Borrowers focus on whether the account is an NPA. Advocates focus on the day it happened, because several other rights and clocks hang off the date of NPA classification.

• SARFAESI. A notice under Section 13(2) of the SARFAESI Act 2002 cannot issue before the account is validly classified. If the classification date is wrong or unsupported, everything built on the notice is exposed, which is one of the standard grounds to challenge a bank auction sale.
• Wilful defaulter examination. The Reserve Bank’s 2024 Direction requires the lender to complete the wilful default examination within six months of NPA classification. The date fixes that window, which matters if you are facing a wilful defaulter classification.
• Limitation. The date of default and the date of classification are separate things, but both feed into the limitation analysis in any recovery proceeding.
• Income recognition. Once an account is an NPA, interest is not to be taken to income on an accrual basis. That affects how the outstanding is computed and is a fertile area for reconciliation disputes.
• Credit reporting. The date drives what appears on the credit record and for how long.

If you think the date is wrong

This is a documents exercise, and it is worth doing properly before any argument is made.

1. Ask for the statement of account for the full period, along with the NPA date the bank has recorded. Ask in writing. For a public sector bank, an application under the Right to Information Act 2005 for your own account records is often more effective than a branch request.
2. Line up due dates against credit dates. Build a chart. Every limitation and classification argument is ultimately a date chart.
3. Check appropriation. Where credits were applied to interest, charges or another facility first, the arithmetic of the arrears changes.
4. Check drawing power workings for cash credit accounts, including which stock statements were on record and how the margin was applied.
5. Check whether a restructuring was in force. A restructured account carries its own asset classification consequences, and a classification that ignores an approved restructuring is worth questioning.

A word about non-banking finance companies. NBFCs were historically allowed longer periods before an account turned non-performing. Under the scale based regulation framework the Reserve Bank moved them to the same 90 day standard through a phased glide path. If your lender is an NBFC and the account is an old one, check which norm applied on the date the lender claims, because the answer is not the same for every year.

Mistakes that cost borrowers money

• Paying a token amount before a hearing. It does not upgrade the account and it may be treated as an acknowledgment that restarts limitation against you.
• Letting stock statements lapse. This is the quietest way to turn a working account irregular.
• Accepting the recall figure without reconciliation. Recall notices routinely include interest computed on an accrual basis after the NPA date, and charges that need to be justified line by line.
• Assuming a moratorium or a rescheduling letter stops the clock. Only a properly approved restructuring does, and it carries its own consequences.
• Waiting for the auction notice. Almost every option a borrower has, from a representation to a tribunal application, works better before enforcement starts than after.

Banking and recovery work of this kind, on both the lender and borrower side, sits within our banking and debt recovery practice and comes before DRT Jabalpur.

This post is general information about the Reserve Bank’s asset classification norms as they currently stand, and not legal advice on any particular loan account. Classification questions turn on the actual entries in the account, so get the statement first. To discuss your own facts, use the contact page.