IndAS and Indian Banks

 

Ind-AS refers to Indian Accounting Standards and they have been formulated keeping the Indian economic & legal environment with a view to converge accounting standards in India with International Financial Reporting Standards (IFRS).

The RBI had issued a circular in February 2016 requiring Scheduled Commercial Banks (SCB) to implement Indian Accounting Standards (Ind-AS) in order to bring Indian accounting standards in line with international standards, and prepare standalone and consolidated Ind-AS financial statements with effect from 1 April, 2018. However, in April 2018 RBI deferred the applicability of Ind AS by one year, i.e., implementation was to be effective from 1 April, 2019. Later, RBI issued a circular in March 2019 which deferred the implementation of Ind-AS till further notice, giving the reason that implementing Ind-AS would require amendments to be made by the government to the relevant banking laws. The legislative amendments recommended by the RBI are still under consideration by the Government of India.

Financial institutions like banks, preparing their financial statements under Ind-AS norms would, inter alia, have had to calculate Expected Credit Losses (ECL) on their loans and advances during each reporting period and make necessary adjustments to their profit-and-loss account even before a borrower had defaulted on a certain loan.

Presently, SCBs are required to make loan loss provisions based on an “incurred loss” approach, which implies that they need to provide for losses that have already occurred / incurred.

Since classification of a loan as NPA normally takes place after a loan becomes overdue, the loan loss provisions are only made thereafter. By this time the borrower may have started facing financial difficulties which is reflective of increased credit risk faced by the banks which is not captured by existing accounting norms.

Ideally, the bank should have recognized the increase in the credit risk and started making provisions for the losses that would be expected in such exposure much before the default happened let alone the subsequent classification of the exposure as NPA.

The adoption of Ind-AS could, therefore, cause banks to proactively recognise losses on their loans and build up the necessary underlying provisions. This would lead to increase the reported level of NPAs and banks who have more to hide would naturally try to avoid adopting Ind-AS accounting norms for as long as possible.

At the same time, implementing Ind-AS would put further pressure on the Central government to increase the amount of funds required for recapitalisation our PSU banks. This would further exacerbate their already stretched fiscal situation.  

One of the pillars of sound banking regulation is effective use of disclosure as a lever to strengthen market discipline and encourage sound banking practices. That is, more transparent financial disclosures would force banks to be more careful in their banking practices and make for sounder and healthier banks.

In this regard it is interesting to note the ground level reality as reflected in the Annual Reports (for FY 2021-22) of some major banks. For this article a sample consisting of Axis Bank, HDFC Bank, and SBI has been considered.

HDFC Bank reports that it being an associate of HDFC Ltd. submits its consolidated financial information prepared in accordance with the recognition and measurement principles of IndAS to HDFC Ltd for the purposes of its consolidated financial statements / results.

Axis Bank reports that, it is in the process of implementing necessary changes in its IT systems wherever required and other processes in a phased manner and it is also submitting Proforma Ind AS financial statements to RBI on a half-yearly basis.

SBI blandly mentions in its AR that it is already geared up for implementation of Ind-AS. However, implementation of Ind AS in Banks has been deferred by RBI until further notice. No further information is given. Thus implying that its reported financials are not IndAS compliant.

The level of transparency practised by these banks should be apparent from the above.

Is it a wonder that there is such a wide divergence as to how the market perceives these banks as reflected in their stock prices!

This does not bode well for the health of the banking system as banks that do not recognise their problems have much lesser pressure to resolve them.

The pain is likely to continue till GOI puts in place structural reforms for putting the governance of PSU banks on sounder footing.