Advanced Auditing, Assurance and Professional Ethics · Special Features of Audit of Banks & Non-Banking Financial Companies

NBFC Prudential Norms and Audit Reporting

Q: After how many days does an NBFC loan become an NPA?

A loan becomes an NPA when principal or interest is overdue for more than 90 days. Under scale-based regulation this norm applies across the layers, but Base layer NBFCs had transition provisions to reach it. Count from the due date and confirm against current RBI directions.

Q: How is a doubtful asset different from a sub-standard asset?

A sub-standard asset has been an NPA for up to 12 months. Once it has remained sub-standard for 12 months it becomes doubtful, and the doubtful period is counted from that point. The provision also changes: sub-standard takes a general provision of 10% of the total outstanding, while doubtful takes 100% of the unsecured part plus a percentage of the secured part. Always follow the facts given in the question.

Q: What is the minimum capital adequacy ratio for an NBFC?

The usual exam test is a minimum CRAR of 15% of risk-weighted assets with Tier 1 capital of at least 10%. These are illustrative figures of the kind used for ICC-type NBFCs, not requirements for every layer. If the question gives a CET1 minimum, test that too, and remember that Tier 2 counted cannot exceed Tier 1. Take the layer-specific figures from the question or the current RBI directions.

Q: What is the impairment reserve in an Ind AS NBFC?

It is a reserve created when the ECL provision under Ind AS 109 is lower than the provision required by RBI's prudential norms. The difference is moved from profit to the reserve. It is not available for dividend distribution.

Q: What does the auditor of an NBFC report besides the audit opinion?

The auditor reports on matters required by RBI's auditor directions, such as registration, net owned fund, public deposit acceptance and compliance with prudential norms. Certain exceptions must be reported to RBI. The auditor also follows the Companies Act reporting, including CARO where applicable.

Updated 5 October 2026 · Fact-checked

NBFC prudential norms are RBI rules on how a non-banking finance company classifies loans, makes provisions, recognises income and holds minimum capital. To solve a question, classify each asset by overdue period, compute the provision, test capital adequacy, check income recognition, then state the auditor's finding and reporting duty to the Board and RBI.

Understand NBFC Prudential Norms and Audit Reporting

An NBFC lends and invests like a bank but does not take demand deposits. RBI regulates it to protect lenders and the financial system. The prudential norms are the core of that regulation. They stop an NBFC from showing profits on loans that are not being repaid, and from running with too little capital.

The norms work in four linked parts. Asset classification sorts each loan or investment by how long it has been overdue. Provisioning sets aside a charge against profit that rises as the asset worsens. Income recognition says that interest on a non-performing asset (NPA) is booked only when actually received. Capital adequacy says the NBFC must hold enough capital against its risk-weighted assets.

Under RBI's scale-based regulation, NBFCs sit in layers (Base, Middle, Upper, Top), and the stricter rules apply to the higher layers. The 90-day NPA norm now applies across the layers, including the Base layer, but Base layer NBFCs have had transition provisions to move to it. Capital requirements differ by layer, and the Upper layer has an extra Common Equity Tier 1 (CET1) requirement. Check the current RBI directions for the layer in the question. Questions normally tell you the layer or give the figures.

NBFCs that follow Ind AS must compute expected credit loss (ECL) under Ind AS 109. RBI still requires the old-style norms provision to be worked out. If the Ind AS provision is lower than the norms provision, the shortfall is moved from profit to an impairment reserve. The reserve cannot be distributed as dividend. This is a favourite exam point.

The auditor checks that the NBFC applies these norms correctly. Apart from the normal audit opinion, the auditor reports to the Board and, under RBI's auditor-reporting directions, on matters such as registration, net owned fund, deposit acceptance and compliance with prudential norms. Some matters must be reported to RBI directly. In the exam, link every finding to a provision, the facts and a conclusion.

Key rules to remember

NPA test: Asset is an NPA when principal or interest is overdue for more than 90 days; The 90-day norm applies to NBFCs across the layers under scale-based regulation. Base layer NBFCs had transition provisions to reach it, so follow the dates given in the question or the current RBI directions. Count days from the due date, not from the date of the audit.
Sub-standard asset: NPA for a period not exceeding 12 months; General provision of 10% of the total outstanding. Apply it to the total outstanding and follow the facts given in the question if they call for a different treatment.
Doubtful asset: NPA that has remained sub-standard for 12 months; the doubtful period is counted from that point; Provision: 100% of the unsecured portion, plus 20% (doubtful for up to 1 year), 30% (1 to 3 years) or 50% (more than 3 years) of the secured portion.
Loss asset: Asset identified as loss by the NBFC, its auditor or RBI, and not written off; Provision: 100% of the outstanding.
Unsecured portion: Unsecured portion = Outstanding − Realisable value of security; Use the realisable value, not the original value of the security.
Capital adequacy ratio (CRAR): CRAR = (Tier 1 capital + eligible Tier 2 capital) ÷ Risk-weighted assets × 100; The usual exam test is a minimum CRAR of 15% with Tier 1 at least 10%. These are illustrative figures of the kind used for ICC-type NBFCs, not requirements for every layer. Use the minimums the question gives, and if it gives a CET1 minimum, test CET1 as well. Tier 2 counted cannot exceed 100% of Tier 1. Take layer-specific figures from the question or the current RBI directions.
Income recognition: No income on NPAs until actually received; reverse interest accrued but unrealised; Under Ind AS, interest on Stage 3 assets is computed on the net carrying amount (after ECL).
Impairment reserve (Ind AS NBFCs): If Ind AS 109 provision < norms provision, transfer the difference from profit to impairment reserve; Compare asset-class-wise. The reserve is not distributable.
Statutory reserve fund: Transfer at least 20% of net profit each year to the reserve fund; Required under Section 45-IC of the RBI Act. The transfer is made out of net profit as disclosed in the profit and loss account, before any dividend is declared.

How to solve NBFC Prudential Norms and Audit Reporting questions

Use this order for any NBFC prudential norms or audit reporting question. It keeps your answer in the provision-facts-conclusion form examiners expect.

1Read the facts and note the NBFC layer, whether it follows Ind AS, and the overdue period of each asset.
2Classify each asset as standard, sub-standard, doubtful or loss. Count overdue days from the due date and check the 90-day cut-off. An NPA becomes doubtful once it has remained sub-standard for 12 months, and the doubtful period is counted from that point.
3Work out the provision, following the facts given in the question. For a sub-standard asset, apply 10% to the total outstanding. For a doubtful asset, split the outstanding into secured and unsecured portions using realisable value of security, then apply the percentage for the class.
4For Ind AS NBFCs, compare the ECL provision with the norms provision and show any transfer to the impairment reserve.
5Check income recognition. Interest on NPAs should not be booked unless received, and unrealised interest already booked should be reversed.
6Compute capital adequacy: cap Tier 2 at 100% of Tier 1, add Tier 1, divide by risk-weighted assets, and compare with the minimums given in the question or current RBI directions (15% CRAR and 10% Tier 1 are the usual illustrative exam figures). If the question gives a CET1 minimum, test CET1 as well.
7State the audit consequence: the adjustment needed, the effect on profit and disclosure, and whether the auditor must modify the opinion or report to the Board or RBI.
8Write the conclusion in one line: compliant or not, and what the auditor will report.

Quickest way: Classify, provide, then test capital

When to use it: Use this for numerical or scenario MCQs where you have little time and only need the classification, provision or ratio.

Underline the overdue days and convert them: over 90 days means NPA; up to 12 months as NPA is sub-standard; once it has remained sub-standard for 12 months it is doubtful, and the doubtful period counts from that point.
For sub-standard, multiply the total outstanding by 10%, unless the facts in the question say otherwise.
For doubtful, take the unsecured portion at 100% and the secured portion at 20%, 30% or 50% by the time spent as doubtful.
For CRAR, cap Tier 2 at Tier 1 first, then add and divide by risk-weighted assets.
Compare with the minimums stated in the question. If none are stated, the usual illustrative exam figures are 15% CRAR and 10% Tier 1, which are of the kind used for ICC-type NBFCs. If the question gives a CET1 minimum, check CET1 against it, and use any layer-specific figures the question or current RBI directions give.

Common mistakes in NBFC Prudential Norms and Audit Reporting

Applying the provision percentage to the secured portion only for a sub-standard asset.
Students mix up the sub-standard rule with the doubtful rule, where secured and unsecured portions are treated differently.
Fix: For sub-standard assets, apply 10% to the total outstanding. Split into secured and unsecured parts for doubtful assets. Always follow the facts given in the question.
Counting the age of a doubtful asset from the date the loan became overdue.
The asset is an NPA for the whole period, so students use the full NPA age.
Fix: An asset is doubtful only after it has stayed sub-standard for 12 months. Use the time spent in the doubtful category to pick the 20%, 30% or 50% rate.
Adding all Tier 2 capital to Tier 1 when computing CRAR.
Students forget the cap and treat all capital as eligible.
Fix: Limit Tier 2 to 100% of Tier 1 before adding. Then check the Tier 1 ratio separately.
Letting interest accrue on an NPA because the borrower may pay later.
Accrual accounting feels natural, so students book income as earned.
Fix: State that income on NPAs is recognised only on receipt, and that unrealised interest already booked is reversed.
Ignoring the impairment reserve for an Ind AS NBFC when the ECL provision is lower than the norms provision.
Students think Ind AS replaces RBI norms entirely.
Fix: Always compare the two. Transfer the shortfall from profit to the impairment reserve and mention that it is not distributable.
Writing only a general audit opinion and omitting the NBFC-specific reporting.
Students treat an NBFC like any other company.
Fix: Add the reporting to the Board and the points required under RBI's auditor directions, including registration, net owned fund, deposit acceptance and prudential compliance.

Worked examples

Example 1

An NBFC (Middle layer) has a secured term loan with outstanding of ₹80,00,000. The borrower has stopped paying and the account has been an NPA for 14 months. The realisable value of the security is ₹60,00,000. The NBFC has made no provision. Classify the asset, compute the provision required and state the auditor's response.

Show the solution

Classification: the account is overdue beyond 90 days, so it is an NPA. It was sub-standard for the first 12 months of its NPA life. After remaining sub-standard for 12 months it became doubtful. With 14 months as an NPA, it has been doubtful for 2 months, which is up to 1 year.
Secured portion = realisable value of security = ₹60,00,000.
Unsecured portion = ₹80,00,000 − ₹60,00,000 = ₹20,00,000.
Provision on unsecured portion = 100% × ₹20,00,000 = ₹20,00,000.
Provision on secured portion = 20% × ₹60,00,000 = ₹12,00,000 (doubtful for up to 1 year).
Total provision = ₹20,00,000 + ₹12,00,000 = ₹32,00,000.
Auditor's response: the absence of provision is a material misstatement. Ask management to record ₹32,00,000. If management refuses, modify the opinion, and report the non-compliance with prudential norms in the reporting required by RBI.

Answer: The asset is a doubtful asset. The required provision is ₹32,00,000. Without it, profit is overstated and the auditor should modify the opinion and report non-compliance with prudential norms.

Example 2

An NBFC has Tier 1 capital of ₹120 crore, of which Common Equity Tier 1 (CET1) is ₹110 crore. Its Tier 2 capital is ₹150 crore and risk-weighted assets are ₹1,200 crore. The question gives these minimums for illustration: CRAR 15%, Tier 1 ratio 10% and CET1 ratio 9%. Compute the ratios and state the auditor's conclusion.

Show the solution

Eligible Tier 2 is capped at 100% of Tier 1, which is ₹120 crore. Tier 2 of ₹150 crore is therefore restricted to ₹120 crore.
Total eligible capital = ₹120 crore + ₹120 crore = ₹240 crore.
CRAR = ₹240 crore ÷ ₹1,200 crore × 100 = 20%.
Tier 1 ratio = ₹120 crore ÷ ₹1,200 crore × 100 = 10%.
CET1 ratio = ₹110 crore ÷ ₹1,200 crore × 100 = 9.17% (rounded to two decimals).
Comparison with the minimums given in the question: CRAR of 20% is above 15%. Tier 1 ratio of 10% meets the minimum of 10%, with no headroom. CET1 of 9.17% is above the 9% minimum, with very little headroom.
Conclusion: the NBFC meets the minimums given in the question. These minimums are illustrative figures supplied by the question, not a statement of the requirements for any particular layer, so in practice check the layer-specific norms in the current RBI directions. The auditor should check the risk weights used and point out that Tier 1 and CET1 are at or near the minimums, so any rise in risk-weighted assets or loss of capital could cause a breach.

Answer: CRAR is 20%, the Tier 1 ratio is 10% and the CET1 ratio is about 9.17%. All meet the minimums given in the question, so the NBFC is compliant on these tests, but Tier 1 and CET1 have little or no margin. The auditor should verify the risk-weighted asset computation.

Exam tips

Write the classification before the provision. Marks are usually split between the two, so show both clearly even if your arithmetic slips.
Show the secured and unsecured split as separate lines in doubtful asset questions. Partial marks depend on it.
In an Ind AS NBFC case, state the ECL versus norms comparison and the impairment reserve, even if the numbers are simple.
For the theory questions on reporting, use the provision-facts-conclusion form: the RBI requirement, what the auditor found, and the effect on the report.
In MCQs on CRAR, check the Tier 2 cap first. One option is usually built on the uncapped figure.

Practice questions from Special Features of Audit of Banks & Non-Banking Financial Companies