What is SMA, NPA, and Provisioning for NPA? 

“PSU banks suffering due to NPA mess”

“Banks see depleting capital due to high NPAs”

“Banks unable to meet capital adequacy norms as NPAs erode capital.”

“Banks report huge losses on account of higher provisioning.”

“RBI’s stricter norms on SMA and NPA can hurt banks further.”

We often come across such headlines in newspapers. We often think of terminologies like SMA and NPA as typical banking jargon which are only used in banking proceedings. But you know what what’s the interesting part is? These SMA and NPA are something that fluctuates the finances and capital of any banking institution. 

In this blog, we will delve into gaining in-depth knowledge about the SMA, NPA, and its provisions. At the end, you will be able to understand the whole concept of these SMA in banking, NPA provisions, classification norms, and much more. 

What is SMA?

As the full form implies, these are Special Mention Accounts that have an increased probability of bad asset quality in the first 90 days. In other words, it is that loan asset/account in which principal or interest payment or both are overdue but for a period less up to 90 days. It may also refer to an account which is showing any other non-financial signs of stress.

In 2014, the RBI introduced the classification of Special Mention Accounts (SMA) to identify accounts with the potential to become NPAs/Stressed Assets. This categorisation aids in early detection and better problem management. The four types of Special Mention Accounts are SMA-NF, SMA 0, SMA 1, and SMA 2, each signifying accounts that might soon turn into NPAs. 

Now, let’s understand the meaning of these better and how they impact the financials and capital of a bank/financial institution.

The first thing to remember is that SMA is NOT a NPA; SMA is a precursor to NPA. Let’s understand what NPA is about.

What is NPA? 

It is that loan asset/account in which the principal or interest payment or both have remained overdue for a continuous period of more than 90 days. An asset, including a leased one, is termed NPA when it stops generating income for the bank. If the interest and/or principal instalment of a loan remains overdue for over 90 days for a term loan, or the account remains ‘out of order’ for overdraft/Cash Credit, or bills purchased/discounted remain overdue for over 90 days, such accounts will be categorised as NPAs.

The connection between SMAs and NPAs

SMA accounts can be seen as the early warning signals for potential NPAs.

If a borrower’s loan account becomes an SMA, it implies that the borrower is facing some financial stress, and there is a higher risk of the loan turning into an NPA in the future.

Timely identification and management of SMA accounts are crucial to preventing further deterioration and minimising the number of NPAs on the bank’s books.

SMA Classification:

SMA is categorised into three stages based on the duration of default:

a. SMA-0: Principal or interest payment overdue between 1 to 30 days.

b. SMA-1: Principal or interest payment overdue between 31 to 60 days.

c. SMA-2: Principal or interest payment overdue between 61 to 90 days.

 Management and Resolution:

Banks closely monitor SMA accounts and take necessary actions to resolve the issues causing the borrower’s financial stress.

Timely resolution of SMA accounts can prevent them from becoming NPAs and help maintain the bank’s asset quality.

Once a loan account becomes an NPA, banks need to follow specific guidelines and procedures for the resolution, recovery, or provisioning of these assets.

 Impact on Banking Operations:

High levels of NPAs can adversely affect a bank’s profitability, capital adequacy, and overall financial stability.

Effective management of SMA accounts can help banks reduce the number of NPAs, improving their financial health.

 NPA Classification:

NPAs are classified based on the duration of default, and they are categorised into three main stages:

a. Substandard Assets: Loans and advances that are either current or overdue for less than 90 days. These assets carry a normal risk.

b. Doubtful Assets: Loans and advances that have remained in the sub-standard category for 12 months.

c. Loss Assets: Loans and advances where the loss has been identified by the bank or auditors but not yet fully written off.

Refer to the figure below for a snapshot of the asset classification:

Figure 1: Asset classification

SMA is more of a precautionary measure to recognise financial stress early and therefore take corrective action to contain that stress and prevent an account from turning into a NPA.

Historical Evolution of NPA Classification 

Year	Development	Impact
2000	Introduction of NPA classification norms	Standardization of asset classification
2010	Introduction of SMA framework	Early identification and management of stressed assets
2014	Revised provisioning norms for NPAs	Enhanced risk management and financial stability
2014	Updated minimum provisioning requirements and SMA categories	Improved transparency and regulatory compliance

Provisioning

Banks/FIs are required to set aside a portion of their income as a provision for the loan assets so as to be prepared for any contingent losses that may arise in the event of non-recovery of loans. The amount of provision to be kept by the bank/FI will depend on the probability of loan recovery. This probability of loan recovery is identified based on the asset classification of the loan asset. The minimum provision that a bank has to create for various types of assets is as follows:

Asset classification		Minimum provision
Standard assets		SME & Agri: 0.25% Commercial Residential: 0.75% Commercial: 1% Others: 0.40%
Sub-standard assets		15% of the outstanding amount 25% for unsecured portion
Doubtful Assets	Secured
	Up to 1Y	25%
	1-3Y	40%
	>3Y	100%
	Unsecured	100%
Loss asset		100% of the outstanding amount or estimated loss

As seen in the table above, the provisioning norms for NPA increase as the assets’ quality deteriorates from regular to SMA to NPA status. As such, a higher proportion of NPA assets will reduce the profitability of the bank/FI and could also result in losses for the bank/FI, thereby eroding its capital base.

Note – As per the NPA provisioning norms, there is no separate provisioning to be made for SMA assets. However, this categorisation helps in initiating the resolution process for recovery. As per the Revised Framework for Resolution of Stressed Assets, released in June 2019, banks may start the resolution or Insolvency & Bankruptcy Code (IBC) process within 30 days of default. If there is a delay in the resolution process, then lenders have to make higher provisioning of 35%. First 20% for 180 days and then an additional 15% if no resolution is found within 365 days.

Conclusion

The relationship between SMA and NPA in banking is crucial for identifying early signs of potential loan defaults. Timely detection and resolution of SMA accounts play a vital role in preventing NPAs and ensuring the soundness of the banking system. Effective risk management practices help banks maintain healthy asset quality and sustain their operations in the long run.