Loan Classification-Provision and Core Banking Risks

Core Risks in Banking

In recognition of the importance of an effective risk management system the five core risks that have been advised to manage in these guidelines are:

  1. a) Credit Risk Management,
  2. b) Asset-Liability Management
  3. c) Foreign Exchange Risk Management,
  4. d) Internal Control and Compliance Risk and
  5. e) Money Laundering Risks.

A credit officer needs to have an in-depth knowledge about Credit Risk Management guidelines and functional knowledge or the others for the successful credit operation.

Loan Classification and Provision

Policy on loan classification and provisioning requires loans and advances to be grouped into various categories namely continuous loan, demand loan’, fixed term loan repayable within five years, fixed term loan repayable in more than five years and short-term agricultural and micro credit. Determining the quality of the loans is a precondition for determining the provision requirement for loans. The better the quality of loans the lower the provision requirement. Quality based loans are categorized as Unclassified (UC), Special Mention Account
(SMA), Substandard (SS), Doubtful (DF), and Bad and Loss (BL) representing best to worst quality of loans, respectively. As per the requirement of the policy, loans are to be classified either by using the objective criteria (overdue period) or qualitative judgement. This policy also requires keeping provision on different quality of loans at different rates ranging from 1% to 100%. Provision rates are given below: Category of Loans classified and Off Balance Sheet Activities.
Special Mention Account (SMA)– 1%
Substandard (SS) – 5%
Doubtful (DF)- 20%
Bad and Loss (BL)- 50%
Interest on Substandard (SS), Doubtful (DF) and Bad and Loss (BL) category loans are required to be transferred to interest suspense account instead of crediting to interest revenue account. This exercise on loan classification and provisioning will be done by the banks in every quarter and be reported to respective regulatory authority.

Loan Classification

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