Insights into Editorial: Delaying bad news: on proposed banking reforms

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Insights into Editorial: Delaying bad news: on proposed banking reforms


 

Context:

The Reserve Bank of India postponed the implementation of the Indian Accounting Standards (Ind AS) norms for banks indefinitely, citing the need for amendments to be made by the government to the relevant banking laws.

The move will bring huge relief to the banks which are yet to recognise stressed assets and make necessary provisions as that would require higher capital.

In 2011, the Ministry of Corporate Affairs announced applicability of Indian Accounting Standards (IND AS) to make reporting by Indian companies globally accessible.

MCA had notified Companies (Indian Accounting Standard Rules) 2015, which listed out the applicability and adoption.

 

Implementation of Indian Accounting Standards (Ind AS) norms:

Ind AS or Indian Accounting Standards govern the accounting and recording of financial transactions as well as the presentation of statements such as profit and loss account and balance sheet of a company.

Ind AS has been evolved as a compromise formula that tries to harmonise Indian accounting rules with the  globally accepted International Financial Reporting Standards (IFRS).

The implementation of IndAS for public sector banks requires an amendment to the Banking Regulation Act.

The schedule in BR Act relating to financial statement disclosures needs to be changed to the IndAS format.

Section 29 of the Banking Regulation Act deals with the accounts and balance sheets of public sector banks. Private sector banks are covered by the Companies Act, which is based on the new accounting standards.

The RBI had initially planned to implement the norms starting April 1, 2018 in order to bring Indian accounting standards in line with international standards.

But the Centre’s delay in enacting the necessary amendments had given breathing space for banks for another year.

 

Expected Consequences if Ind AS Norms comes forward:

Given that Ind AS is a principle based standard, the Regulators could provide simplified guidelines for ease of implementation and bringing consistency in implementation amongst banks.

It is believed that the adoption of the accounting standard could cause significant credit losses to banks, which will be forced to prematurely recognise losses on their loans and build up the necessary underlying capital required to overcome the impact of such losses.

Under the proposed norms, financial institutions like banks will have to calculate expected credit losses (ECL) on their loans during each reporting period and make necessary adjustments to their profit-and-loss account even before a borrower may default on a certain loan.

This is in contrast to the present accounting norms wherein banks incur credit losses in their books only after outstanding loans have been in a state of default over a certain number of days as stated in the rules laid down by the RBI.

 

Adopting the Accounting Norms results in Addition to pile up Bad Loans:

For example, the impact of expected credit losses may be spread systematically over a five-year period, thereby allowing time for banks to manage the increase in capital requirements.

According to estimates made by India Ratings & Research, public sector banks would have to make additional provision of over a trillion rupees means of over Rs. 1 lakh-Cr if the norms are adopted right away.

Given the losses they would likely have to incur, it is understandable why banks would try to avoid adopting the accounting norms for as long as possible.

So, the delay in the implementation of the Ind AS norms is not surprising at all.

Further, to adjust to the new norms, banks will have to improve their ability to forecast future credit losses with precision.

Until this happens, bank earnings could experience volatility. The Central government, which has been trying to bail out public sector banks without carrying out the structural reforms required to clean up balance sheets, might also prefer to delay the enactment of the legislation.

For the new norms will cause more outstanding loans to be added to the huge existing pile of bad loans and cause further headaches to the government.

 

Conclusion:

The Centre may not be able to foot the bill to go for legislation process, and may instead prefer to help public sector banks to hide the true size of their bad loans.

The backend system and the other ecosystem probably were not ready. This required a thorough discussion with the auditors on what should be provided

This does not sign of well for the health of the banking system as banks that do not recognise their problems might not resolve them.

In recent times, the banking regulator had raised concerns over ‘divergence’ in asset classification and provisioning, which means the reported numbers of a bank were lower than what RBI’s inspection report had found.

The implementation of Ind AS would have taken care of such issues. In the long run, moving to internationally acceptable accounting standards will help the Indian banking system in becoming more resilient and tapping international pools for their capital requirements.

Introduction of GST, Ind AS, ICDS, etc., are transformational changes, which are steps in the right direction for the country’s growth.

We have formed cross functional teams to prepare for the respective changes in regulations and have also sought external expert support, wherever required, to ensure complete compliance and smooth transition.