Cost of not doing Ind AS now for banks is to high

Back in 2014, Union Finance Minister Late Arun Jaitley made an announcement in the budget speech that “There is an urgent need to converge the current Indian accounting standards with the International Financial Reporting Standards (IFRS)”. India Inc. has come a long way since.

Large Indian corporates have successfully made the transition to Ind AS (the IFRS converged standards for India), and it is almost universally agreed that there is a major improvement in the quality and usefulness of financial statements.

However, constituents of banking and insurance industries remain an exception and, because of deferrals given by their respective regulators, are yet to align themselves with the international standards. They continue to report under the old accounting regime popularly called “Indian GAAP”, and regulator prescribed norms.

There have been valid reasons for the delay. IFRS itself undergoing changes, lack of investment by banks in preparedness, and large scale changes required in the regulations have all been cited. But to be straight, the monster that everyone dreads is the Ind AS provisioning rule – under the Expected Credit Loss (ECL) model – which would not only make banks deal with major data quality, IT capability and quantitative modelling challenges, may actually throw their capital and P&L ratios into the red zone immediately.

RBI, though, has continuously reiterated its intent to implement international standards. Recently, in the RBI Governor’s statement on 30 September 2022, RBI confirmed that they will soon issue a discussion paper on the proposed transition to ECL. Proposed guidelines for asset recognition and measurement (which are in line with Ind AS) are already out from RBI.

Cost of not doing Ind AS now is just too high

Firstly, it is that the current norms of provisioning, based on delinquency status, and called the “incurred loss” model, is a risk for the health of banks and financial system as a whole. Simply said, it results in provisions getting recognized when things have already gone bad, instead of the new “expected loss” model, which aims at provisions being recognized by looking at the risks seen in the future. That helps banks build up adequate buffers. The incurred loss model, because of its procyclicality, was found to exacerbate the downswing during the 2008 financial crisis.

"Adoption of international level prudential norms has a direct impact on credit rating of financial institutions of a country, and also of a country as a whole. The international rating agencies consider the quality of regulatory standards, and rigour with which they have been adopted, and implementation of international reporting standards will be favorable on that front. This would bring down cost of funding, and cost of international transactions, and would be a significant benefit to the economy.."

Further, it is a matter of principle. Internationally, banks have largely adopted it. In India also, the younger sibling, the NBFC sector has adopted it. So with limited excuses left, it is difficult to justify banks not adopting it soon. There are concerns around capital requirement that would follow to cover up for the possibly higher provisions. But effort would need to be made, and solutions would need to be found to keep pace with the world.

It is widely believed that implementation of Ind AS would also bring improvements around underwriting and lending policies, risk sensitive pricing, risk management, and corporate governance.

A hurried transition period though, can result in inconsistent and unreliable application, especially on areas like provisioning. It has been seen that the countries that give adequate time for implementation of any new standards do it well, and then their baseline quality of financial reporting remains high. India’s implementation of Ind AS for other industries falls in this category. However, if implementation is rushed then quality achieved is poor, and it then takes years to correct the situation, causing lasting damage to integrity of the financial reporting system.

A well thought out transition roadmap and guidelines around supervisor’s expectations on the ECL framework would enable the industry achieve the desired benefits.

For the insurance sector on the other hand, it made little sense in implementing Ind AS, when IFRS’s project for the new international standard for insurance contract wasn’t completed. Now that it is expected to be effective from next year though, it is interesting to see whether MCA and the IRDAI make their move soon, or wait for the international community to apply it first. There certainly are benefits of transitioning a year or two later.

All things said, it seems to be more a question of when, rather than if, the two important industries will adopt the international standards. But how the implementation is made effective is also extremely important. Regulators’ role in providing adequate time for implementation, and timely clarifications on areas of judgment would enable a consistent and successful transition.