Introduction
Income Recognition and Asset Classification are important parts of a bank’s credit-risk and balance-sheet management framework.
The basic principle is simple:
A bank should recognise income according to the actual performance of the loan and classify the asset according to objective regulatory criteria.
A weak loan cannot be kept as a performing asset merely because:
adequate security is available;
the borrower has a high net worth;
recovery is expected in future; or
the bank wants to avoid reporting an NPA.
The Reserve Bank of India requires banks to identify stress objectively and at an early stage.
For CAIIB, the important sequence is:
Due Date → Overdue → SMA → NPA → Substandard → Doubtful → Loss
However, this sequence must be understood carefully because SMA is an early-warning classification, whereas substandard, doubtful and loss are categories of non-performing assets.
The current framework for commercial banks is contained in the RBI Commercial Banks – Income Recognition, Asset Classification and Provisioning Directions, 2025, updated up to July 1, 2026. RBI has also issued a new Asset Classification, Provisioning and Income Recognition framework in April 2026, but it becomes effective only from April 1, 2027.
IIBF specifically advises candidates to prepare for current developments even where they are not expressly listed in the syllabus.
Learning Objectives
After studying this topic, you should be able to:
explain the basic principles of income recognition and asset classification;
distinguish overdue, SMA and NPA status;
identify SMA-0, SMA-1 and SMA-2 correctly;
apply the 90-day NPA rule to common credit facilities;
understand the meaning of “out of order” for CC/OD accounts;
distinguish standard, substandard, doubtful and loss assets; and
identify major CAIIB traps involving income recognition and early stress.
What Is the IRAC Framework?
IRAC commonly refers to:
Income Recognition, Asset Classification and Provisioning.
The framework aims to present a realistic picture of the quality of a bank’s loan portfolio.
Its three elements are closely connected:
Income Recognition
Determines when interest and other income can be recognised in the bank’s Profit and Loss Account.
Asset Classification
Determines whether an advance is:
Standard;
Substandard;
Doubtful; or
Loss.
Provisioning
Determines how much amount must be set aside against possible losses based on the applicable asset category, security position and regulatory requirements.
The core regulatory principle is that recognition and classification should be based on objective evidence and the record of recovery, rather than subjective expectations.
Standard Asset and Non-Performing Asset
A standard asset is a performing asset that does not carry more than the normal risk attached to the business.
An asset becomes a Non-Performing Asset (NPA) when it ceases to generate income for the bank.
For a normal term loan, the major test is whether:
interest and/or an instalment of principal remains overdue for more than 90 days.
For CC/OD accounts, the test is whether the account becomes out of order.
Different rules also apply to bills, specified agricultural loans and certain special categories. The current commercial-bank directions retain the 90-day framework for normal term lending and define the separate “out of order” conditions for CC/OD facilities.
Meaning of Overdue
An amount becomes overdue when it is not paid on the due date fixed by the bank.
This definition is important.
The 90-day period does not start after giving an additional informal grace period unless a specific regulatory or contractual rule provides otherwise.
Banks identify overdue status through their day-end process.
Therefore, if an instalment is due today and the full amount is not received before the relevant day-end processing, the amount becomes overdue from that date.
This creates the starting point for SMA and eventual NPA classification.
SMA – Special Mention Account
A Special Mention Account is an account showing incipient financial stress.
SMA classification allows the bank to identify weakness before the account becomes an NPA.
Under the current RBI Resolution of Stressed Assets framework for commercial banks, stress must be recognised immediately on default.
SMA Classification for Loans Other Than Revolving Facilities
Category | Overdue Position |
|---|---|
SMA-0 | Up to 30 days |
SMA-1 | More than 30 days and up to 60 days |
SMA-2 | More than 60 days and up to 90 days |
NPA | More than 90 days, subject to applicable NPA rules |
The classification applies to principal, interest or any other amount that is wholly or partly overdue.
The RBI framework applies these SMA categories to loans including retail loans, except agricultural advances governed by crop-season-based asset classification norms.
SMA Treatment for Cash Credit and Overdraft
Revolving facilities such as Cash Credit and Overdraft require separate treatment.
For these facilities, RBI’s SMA framework considers the period for which the outstanding remains continuously above:
Sanctioned Limit or Drawing Power, whichever is lower.
The categories are:
SMA Category | Continuous Excess Position |
|---|---|
SMA-1 | More than 30 days and up to 60 days |
SMA-2 | More than 60 days and up to 90 days |
Unlike normal term loans, the regulatory table does not prescribe an SMA-0 category based on this continuous-excess test for revolving facilities.
This distinction is important for CAIIB.
What Does “Out of Order” Mean?
A CC/OD account is treated as out of order if any of the following situations exists:
The outstanding remains continuously above the sanctioned limit or drawing power, whichever is lower, for 90 days.
The outstanding is within the sanctioned limit/drawing power, but there are no credits continuously for 90 days.
Credits are received, but they are not sufficient to cover the interest debited during the previous 90 days.
These conditions are extremely important because an account can become NPA even when the balance is technically below the sanctioned limit.
The current RBI directions specifically retain all three tests.
Example
Suppose a borrower has a CC limit of ₹50 lakh and the outstanding remains ₹45 lakh.
A learner may think:
“Outstanding is below the sanctioned limit, so the account cannot become NPA.”
That conclusion may be wrong.
If there have been no credits for 90 days, or the credits during the relevant period are insufficient to service the interest debited, the account can meet the out-of-order condition.
Difference Between SMA and NPA
Basis | SMA | NPA |
|---|---|---|
Meaning | Early sign of financial stress | Non-performing asset |
Main purpose | Early identification and corrective action | Regulatory asset classification |
Categories | SMA-0, SMA-1, SMA-2 | Substandard, Doubtful, Loss |
Income treatment | Account may still remain standard | Income recognition shifts to applicable NPA treatment |
Provisioning impact | Normally remains governed by applicable standard/stressed exposure rules | NPA provisioning rules apply |
Recovery focus | Prevent deterioration | Recovery/resolution becomes more serious |
SMA should therefore not be treated as another category of NPA.
It is a pre-NPA warning mechanism.
Day-End Classification
RBI requires stress and asset status to be recognised using the relevant day-end processing.
This prevents banks from using inconsistent intra-day or discretionary approaches.
The practical sequence is:
Payment Due → Not received by day-end → Overdue status begins → SMA status develops according to ageing → NPA classification when regulatory criteria are met
This has made correct understanding of dates particularly important in CAIIB case questions.
A common trap is to start counting overdue days from the day after the due date instead of applying the regulatory day-end principle.
NPA Identification for Major Credit Facilities
Term Loans
A term loan becomes NPA when interest and/or instalment of principal remains overdue for more than 90 days.
Cash Credit and Overdraft
The account becomes NPA when it satisfies the regulatory out-of-order test.
Bills Purchased and Discounted
A bill becomes NPA when it remains overdue beyond the prescribed 90-day period.
Agricultural Advances
Specified agricultural advances follow a crop-season-based test instead of the normal 90-day rule.
Broadly:
Short-duration crops: principal or interest overdue for two crop seasons.
Long-duration crops: principal or interest overdue for one crop season.
The crop-season treatment applies only to qualifying agricultural advances; agricultural-related lending does not automatically receive this special treatment.
Asset Classification After an Account Becomes NPA
Once an asset becomes NPA, it is further classified according to the seriousness and duration of impairment.
Substandard Asset
A substandard asset is an asset that has remained NPA for a period of up to 12 months.
Doubtful Asset
An asset becomes doubtful after remaining in the substandard category for 12 months.
Loss Asset
A loss asset is one where loss has been identified by the bank, auditors or RBI inspection, but the amount has not been wholly written off.
The current commercial-bank directions retain these definitions.
Income Recognition on Standard Assets
For a performing or standard credit facility, income can generally be recognised on an accrual basis.
This means interest income is recognised as it accrues, subject to applicable regulatory and accounting requirements.
The position changes when the asset becomes non-performing.
Income Recognition on NPAs
Under the current framework, income on a credit facility that is not classified as standard is recognised on an actual receipt or cash basis, rather than merely because interest has accrued in the bank’s books. This principle also applies to Government-guaranteed accounts for income-recognition purposes.
Therefore:
Standard Asset → Accrual Basis
NPA → Actual Realisation/Cash Basis
This prevents unrealised interest on weak assets from artificially increasing reported profit.
Reversal of Unrealised Income
If an advance becomes NPA after interest has already been accrued and credited to income but remains unrealised, the applicable unrealised income must be reversed or otherwise treated as required under RBI norms.
The logic is important:
Profit should not include income that the bank has not actually realised from a non-performing asset.
Security Does Not Decide Whether an Account Is NPA
A major conceptual trap is to link NPA classification directly with the value of collateral.
Suppose a borrower has defaulted and the bank holds property worth much more than the loan balance.
The account does not remain standard merely because the security is valuable.
NPA identification is primarily based on regulatory performance criteria such as:
overdue status;
out-of-order status;
applicable crop-season norms; and
other specific RBI conditions.
Security becomes highly relevant for matters such as provisioning and recovery, but it does not normally prevent NPA classification merely because collateral coverage is strong.
Borrower-Wise Classification
Asset classification generally follows the borrower-wise principle, rather than allowing each facility of the same borrower to be treated independently simply because one facility remains regular.
This prevents a situation where a borrower is materially in default in one facility while another facility is shown as performing without considering the broader relationship.
Therefore, when a borrower has several facilities with the same bank, the examiner may expect the learner to examine the effect of default across the borrower’s facilities.
There are specific regulatory exceptions and treatments for certain exposures, so the general borrower-wise principle should not be applied blindly to every special case.
Upgradation from NPA to Standard
A loan classified as NPA does not become standard merely because:
one instalment is paid;
interest for one month is deposited;
the account temporarily comes within limit; or
a small recovery is made before the balance-sheet date.
Under the regulatory approach, upgradation normally requires payment of the entire arrears of interest and principal.
Where the borrower has more than one credit facility with the bank, the arrears relating to all relevant facilities must be considered for upgradation. The same principle has long been embedded in RBI’s asset-classification framework.
Accounts Regularised Near the Balance-Sheet Date
CAIIB may test accounts that suddenly receive credits just before March 31 or another reporting date.
Banks must look at the genuine performance of the account, not merely a temporary credit introduced to prevent NPA classification.
If the account shows inherent weakness and the regularisation is doubtful or temporary, the bank should examine the circumstances carefully.
The objective of IRAC is to reflect the real quality of the asset, not to permit artificial regularisation or evergreening.
RBI’s stressed-asset framework warns that actions intended to conceal the actual status of accounts or evergreen stressed accounts can attract supervisory or enforcement action.
SMA and Early Stress Management
SMA classification is not simply a reporting label.
It should trigger closer monitoring.
Examples of actions include:
contacting the borrower;
examining reasons for delayed payment;
reviewing cash flow;
checking stock statements and receivables;
reviewing account turnover;
identifying diversion of funds;
examining financial deterioration;
checking other lender exposure;
reviewing security and documentation; and
considering suitable resolution measures where required.
The earlier the bank identifies stress, the greater the possibility of preventing deterioration into NPA.
CRILC Reporting
RBI uses the Central Repository of Information on Large Credits (CRILC) to monitor larger credit exposures and stress across the banking system.
Under the current commercial-bank stressed-asset directions, banks report credit information, including SMA classification, to CRILC for borrowers having aggregate exposure of ₹5 crore and above. Monthly reporting applies, along with specified weekly default reporting for borrowers within the applicable exposure threshold.
This does not mean that SMA classification itself applies only to accounts of ₹5 crore and above.
SMA classification applies much more broadly.
The ₹5 crore threshold relates to the specified CRILC reporting requirement.
This distinction is important for CAIIB.
Current Regulatory Transition – ECL from April 1, 2027
RBI issued the Commercial Banks – Asset Classification, Provisioning and Income Recognition Directions, 2026 on April 27, 2026.
However, these Directions become effective from April 1, 2027.
Until then, commercial banks continue to be governed by the 2025 IRACP Directions.
The 2026 framework introduces a forward-looking Expected Credit Loss (ECL) approach with three stages:
Stage 1: no significant increase in credit risk since initial recognition, or low credit risk;
Stage 2: significant increase in credit risk, but not credit-impaired;
Stage 3: credit-impaired.
Importantly, RBI has retained the existing regulatory NPA identification framework alongside the new ECL staging approach. IIBF has already highlighted this regulatory change in its 2026 learning updates.
CAIIB Exam Focus
1. SMA Is Not NPA
SMA represents early stress before NPA classification.
2. Remember the SMA Sequence
For normal non-revolving loans:
SMA-0 → up to 30 days
SMA-1 → more than 30 up to 60 days
SMA-2 → more than 60 up to 90 days
3. Do Not Apply Term-Loan Logic Blindly to CC/OD
CC/OD facilities must be tested for out-of-order status.
4. Below Limit Does Not Always Mean Regular
A CC account may be below its sanctioned limit and still be out of order due to lack of credits or inadequate credits for servicing interest.
5. Security Does Not Automatically Prevent NPA Classification
Asset classification depends mainly on regulatory performance criteria.
6. SMA Reporting Threshold and SMA Classification Are Different
The CRILC threshold must not be confused with applicability of SMA classification.
7. Agricultural Loans Can Follow Crop-Season Norms
Do not automatically apply the normal 90-day test to qualifying agricultural advances.
8. Income Recognition Changes After NPA
Accrued income on a standard asset and actual-realisation treatment on an NPA must be distinguished.
9. Upgradation Requires Genuine Regularisation
A temporary or partial payment is not automatically enough.
10. Know the 2027 Regulatory Change
The ECL framework has been issued but becomes effective from April 1, 2027.
Common Exam Traps
Trap 1: “SMA-2 Means the Account Is Already NPA”
Wrong. SMA-2 indicates serious pre-NPA stress.
Trap 2: “A Loan Becomes Overdue Only After 30 Days”
Wrong. It becomes overdue when the payment is not made on the contractual due date.
Trap 3: “A CC Account Below Limit Cannot Become NPA”
Wrong. The no-credit and insufficient-credit tests can make it out of order.
Trap 4: “Strong Security Keeps the Account Standard”
Wrong. Security does not override the basic repayment-performance test.
Trap 5: “All Agricultural Loans Use Crop Seasons”
Wrong. Only qualifying agricultural advances receive the specified crop-season treatment.
Trap 6: “SMA Applies Only to Large Corporate Borrowers”
Wrong. The applicable SMA framework covers loans including retail loans, subject to specified exceptions.
Trap 7: “Any Recovery Upgrades an NPA”
Wrong. Upgradation requires compliance with the full regulatory conditions.
Trap 8: “The 2026 ECL Directions Are Already Fully Effective”
Wrong as of September 2026. Their effective date is April 1, 2027.
Memory Technique
Remember:
0 – 30 – 60 – 90 – NPA
Think of the stress ladder as:
Default → SMA-0 → SMA-1 → SMA-2 → NPA
Then remember that after NPA classification:
Substandard → Doubtful → Loss
This separates the early-warning stage from the NPA classification stage.
Practical Banking Application
Suppose a branch has three stressed accounts.
Account A: A term-loan instalment has recently become overdue.
The bank should begin tracking overdue ageing and assign the relevant SMA status.
Account B: A CC account is within limit, but there have been no credits for a prolonged period.
The branch should not conclude that the account is healthy merely because it is below the sanctioned limit. The out-of-order criteria must be checked.
Account C: A loan has already become NPA, but the borrower deposits only one monthly instalment just before the reporting date.
The bank should not automatically upgrade the account. It must test whether the complete regulatory conditions for upgradation have been satisfied.
These examples show why IRAC is not simply an accounting exercise.
It connects:
Credit Monitoring → Early Stress Recognition → Correct Income Recognition → Asset Classification → Provisioning → Recovery and Resolution
For CAIIB, the most important approach is to identify the type of facility, establish the due date or operating condition, calculate the age of stress, and then apply the correct regulatory classification.