An NBFC has the following facts as at 31 March 2026: It has classified a loan account as standard.

An NBFC has the following facts as at 31 March 2026:

It has classified a loan account as standard.
The borrower has not defaulted in repayment.
The borrower has, however, breached a financial covenant contained in the loan agreement.
The breach gives the lender a contractual right to demand repayment, but the NBFC has not exercised that right.
The management believes that because no instalment or interest is overdue, the account must necessarily continue to be treated as standard for all prudential purposes.
The statutory auditor identifies that the account also satisfies the conditions prescribed under the applicable RBI framework for a special regulatory treatment arising from the covenant breach.

The engagement partner says:

“The absence of an overdue instalment is sufficient evidence that the account is a standard asset. The auditor need not examine the covenant because classification of a loan depends only on actual payment default.”

Which ONE of the following is the most appropriate conclusion?

A. The partner is correct because prudential classification of a loan is determined exclusively by whether principal or interest has remained overdue.

B. The partner is incorrect because the auditor must consider the applicable RBI prudential requirements relating to the covenant breach even where no instalment is overdue.

C. The partner is correct because a covenant breach becomes relevant for prudential classification only after the lender actually exercises the contractual right to demand repayment.

D. The partner is incorrect only when the covenant breach results in a legally enforceable demand for immediate repayment before the reporting date.