Will new accounting norms hurt bank earnings?

MUMBAI: Amid rising decibels of the demonetisation debate banks are silently preparing for an upcoming event: Ind AS 109 or Indian Accounting Standard, a global accounting practice that lenders are mandated to adopt that may lead to initial credit losses.
Banks including private sector ones like ICICI, HDFC and Axis are actively working on this as they have submitted estimates for such losses to Reserve Bank of India, which is now expected to come out with fresh guidelines on computation of expected credit losses (ECL), a key to banks’ future earnings, three sources familiar with the matter told ET.

“The provisioning requirements under IFRS 9 (International Financial Reporting Standard) may be higher than what you are seeing today because we derive numbers on incurred losses rather than expected losses,” said Jairam Sridharan, CFO, Axis Bank. “There will be an incremental provisioning requirement which will result in higher capital necessity or banks capital ratios will go down because of increased level of provisioning.”

“The industry needs to be prepared for that in some way and the regulator is thinking about it,” he said.

The central bank is currently evaluating these estimates before the final guidelines are put out, they said. Emails sent to RBI, ICICI Bank, HDFC Bank and Kotak Mahindra Bank seeking comments remained unanswered.

Bankers ET spoke with said RBI has set up different working groups to assess the impact of various aspects of Ind AS 109. These multiple working groups are helping the RBI formulate its recommendations to be presented to the industry soon.

Ind Accounting Standard is on par with the International Financial Reporting Standard (IFRS) 9. Indian banks are mandated to comply with it beginning April in 2018. But, the process has to start as early as next financial year as lenders need comparatives to show year-on-year effect in the April-June quarter earnings FY19.

The standard is applicable from 2018-19 with a parallel over last financial year that is 2017-18.

"Despite the demonetization buzz and focus on transaction banking, banks are in course of implementation of another significant change i.e. moving towards Ind- Accounting Standards,” said Kuntal Sur, partner, PwC. “The most important component of the new accounting norms for banks…is covering expected credit losses (ECL).”

“Given the high provisioning witnessed in the last year, the ECL numbers may affect bank’s profit & loss and more for the PSU banks, which have witnessed a high level of bad loans," he said.

Currently, Indian banks are following the Generally Accepted Accounting Principles (GAAP). This requires banks to recognise mark-to-market losses while the new standard will take note of gains as well.

Moreover, banks have to set aside funds anticipating bad loan losses. For example, if a bank gives a loan at 15% for five years but expects repayments in seven years, its yield on advances comes down, hitting interest rate margin.

“Indian bank financials will be more comparable to global banks, which in turn, will evince global investment interest,” said Kalpesh Mehta, partner, Deloitte India. “Ind AS will help bring in the fair value accounting in line with global standard.”

“But, banks have to recognise the expected credit losses at the initial stage,” he said.

According to a February 11 RBI notification, banks shall comply with the Indian Accounting Standards (Ind AS) for financial statements for accounting periods beginning from April 1, 2018 onwards, with comparatives for the periods ending March 31, 2018 or thereafter.

“Ind AS shall be applicable to both standalone financial statements and consolidated financial statements. Comparatives shall mean comparative figures for the preceding accounting period.