Change they must

It is reported that the Indian Banks’ Association (IBA) has requested the RBI to postpone implementation of IndAS, the Indian equivalent of International Financial Reporting Standards, in banks. Ideally, banks and insurance companies should implement IndAS for the year ending March 31, 2019.

The IBA blames the demonetisation drive for this situation. That sounds odd because there is a general consensus that if there is one industry that is not worse off (if not better) after demonetisation, it is banking. Irrespective of all factors, RBI should not give their nod for a postponement.

Out of the 40 IndAS accounting standards applicable now, only one would have the maximum impact on banks — Ind AS 109 on financial instruments. Out of the many requirements of IndAS 109 on classification, recognition, measurement, derecognition and impairment, only the provisions on impairment are expected to have the maximum impact on the financial position of banks. This is due to the fact that the standard has changed the method to provide for losses on bad loans (NPAs).

Existing accounting standards prescribed the incurred loss method as per which banks were providing for credit losses on the basis of occurrence of an event. IndAS 109 mandates entities to move over to an expected loss approach according to which an estimate is to be made for 12-month and lifetime credit losses after regularly assessing the credit quality of the asset.

There is a general consensus that adopting the ECL method would warrant a more aggressive approach to making loss allowances for NPA’s which in turn would result in higher provisions than is being done at present. While this would impact the financials of banks, it would ensure that the responsibility for managing bad loans is on the banks and that loss allowances are made earlier. During the mortgage credit crisis in the US, accounting standards were criticised for recognising too little losses too late — IndAS 109 is the response of the standard-setters to this criticism.

The FSR published by the RBI in December gives further credence to the argument to introduce the ECL model in banks apriori. The report states that the gross NPA ratio of commercial banks increased to 9.1 per cent from 7.8 per cent between March and September 2016, pushing the overall stressed advances ratio to 12.3 per cent from 11.5 per cent.

Given the higher levels of impairment, banks may remain risk averse in the near future as they clean up their balance sheets and their capital position. Specifically, banks need to further increase their provisioning levels to meet the expected losses arising from credit risk.

The bank-wise estimation of losses arising from credit risk shows that 33 banks, which had a 74 per cent share in the total advances of the select 60 banks, may be unable to meet their expected losses with their existing provisions. On the other hand, six banks were estimated to have losses exceeding their total capital. The new approach mandated by IndAS is only going to worsen the scenario.

However, this should not dissuade the banks from adopting the new standard as the true picture of NPAs should be disclosed at some point in time. It would also enable banks to make a realistic assessment of their capital requirements in future.

The writer is a chartered accountant

COMMENT NOW