Question : Why does SBP require the banks to classify their loans?

A) Why does SBP require the banks to classify their loans?

B) What are different catagories of Classification?

C) Differentiate between time-based and subjective classification.which would you prefer for your bank?

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Those who are working in banks especially credits department are well aware of the term "classification".

In common words a classified loan is a loan which is not regular and is experiencing any problem.

Prudential Regulations of SBP comprehensively covers this topic and SBP have provided guidelines for banks to report their loans when they are not behaving regular. Regulation R-11 of PRs deals with the CLASSIFICATION AND PROVISIONING FOR ASSETS.

There are two types of classification, Time-based and subjective. 

In time based its obvious that we have to consider the time period in order to classify the loan,

Annexure III of SME PRs gives the following time based criteria for classification of loans,

Sub-Standard :       Mrak-up/Interest or Principal overdue 90 days or more from due date 

Doubtful :               Mrak-up/Interest or Principal overdue 180 days or more from due date 

Loss:                      Mrak-up/Interest or Principal overdue 365 days or more from due date 

(Time Based classification is different in different sectors, i.e. Agriculture, Consumer. Check PRs of those sectors for further details)

on the basis of this classification the SBP has provided the guidelines to make proper provisioning of income, details of which are available in PRs.

Subjective Classification

In addition to the time-based criteria prescribed in Annexure-III, subjective evaluation of performing and non-performing credit portfolio shall be made for risk assessment and, where considered necessary, any account including the performing account will be classified, and the category of classification determined on the basis 

of time based criteria shall be further downgraded. Such evaluation shall be carried out on the basis of credit worthiness of the borrower, its cash flow, operation in the account, adequacy of the security, inclusive of its realizable value and documentation covering the advances.

Hence, reason for subjective classification can be anything which shows some irregularity in the loan and give a hint that loan is attracting classification. Such classification help banks to make proper provisions and closely monitor such loans in order to minimize risk and NPLs. 

which would you prefer for your bank?

Time-based classification is more standardized and can easily be applied to a large number of clients, preferable in case of small clients.

However, subjective classification is not feasible in case of small loans, therefore, it is suggested for large borrowers.