NPA divergences point to a need for bank auditors to have a dialogue with RBI

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Even as business gets easy in India, banks, especially private sector banks, disclose divergences in non-performing assets (NPAs), for the FY17. This raises questions on the auditors and the banks' management with regards to their assessment of stress in their loan books.

Private sector banks including HDFC Bank, Axis Bank and Yes Bank reported cumulative divergences of Rs 12,000 crore after the Reserve Bank of India asked to make disclosures in classifying select accounts as NPAs as per its inspection, which earlier were not classified by the bank.

It is prescribed that such a disclosure is mandated when the divergence is more than 15 percent.

As per a senior partner at Deloitte, one of the top global audit, consulting and financial advisory firms, "In cases of divergences, prudential norms also have an aspect which says that the RBI auditor believes that the asset is non-performing based on qualitative aspects. This can be due to deterioration of the security value, change in business conditions, delay in cash flows vs what was submitted in the project at the time of lending, etc. RBI maybe goes through the root-cause analysis which the banks may not have done."

This is the second time in a row that the RBI pointed out differences in asset classification and provisioning in its annual risk-based supervision. In FY16, most divergences were reported by private sector banks, while public sector banks did not require any additional disclosures.

For FY16, the top three banks had reported divergences worth Rs 18,760 crore -- ICICI Bank (divergence of Rs 5,105 crore), Axis Bank (Rs 9,478 crore) and Yes Bank (Rs 4,177 crore).

For ICICI Bank, RBI's inspection report for FY17 on divergences is yet to be communicated.

SS Mundra, former banker-turned Deputy Governor at RBI said, "Sometimes, it is quite possible that NPAs may be recognised in one bank and not at another. At times, when the RBI is inspecting, the availability of information is slightly better than the bank auditors and also the timeline is better. There are also interpretation issues. However, this should account for a limited difference."

According to him, there should be a dialogue between the auditors and the regulator. "I think there is a need for people to get sensitive about it. The framework has been put in place in the last two years, so there may be genuine reasons that some parties (banks or auditors) may not be clear. Now that two cycles are over, the bank Board, auditors must pick these up and engage in discussions with the management and the RBI. I would prefer more engagement than judge that as a misconduct on the part of auditors."

Bank disclosures

Last week, mid-sized private lender Yes Bank had reported divergences of Rs 6,355 crore in classification of NPAs as detected by the RBI for the FY17.

Prior to that, Axis Bank disclosed Rs 5,633 crore worth of divergences in its gross NPAs after the RBI inspection.

HDFC Bank has not disclosed the amount a day after it announced its results, was asked by the banking regulator to classify one account as NPA.

Rana Kapoor, MD and CEO of the bank, called it a “temporary setback on asset quality” and said that more than 80 percent of the accounts are meeting the standard accounting norms and 47 percent of it has been upgraded. The bank has absorbed the full impact of the divergence in the second quarter itself.

Jairam Sridharan, CFO of Axis Bank said, “We estimate the divergence related accounts to consume 40 bps of credit costs for the full year. Incorporating this impact, we are updating our credit cost guidance to 220-260 bps for this financial year as against earlier guidance of 175-200 bps.

According to reports, in the coming days, the RBI may question the provisioning methodology and NPA figures arrived at by auditors of the banks.

However, in defense, an auditor said, "The first estimates (of classification) are made by the bank’s management while the auditor only plays the role of reviewing those estimates and taking the judgment of reasonableness of that decision. Most cases, there are also bilateral arrangements with the lenders and the peculiar aspects give a difference assessment which the third party may not know."

The divergence could also be driven by new accounting standards, as India has transitioned its accounting standards from GAAP to Ind-AS, starting April 1, 2016; to be on par with International Financial Reporting Standards (IFRS).

This comes at a time when the credit growth is at its lowest in over five years. RBI’s latest data shows that banks' gross credit as on September end this year grew only 4.2 percent over September last year’s growth of 11.5 percent. Lending to the industry (micro, small, medium and large) de-grew by (-0.4) percent.

"This is not a systemic issue. It is an individual bank issue…In every country, there is a review of the asset classification done by the auditors. So, if  your assumption is true that the auditor who audited a bank wrongly classified an asset, that auditor should be disqualified," said YV Reddy, former Governor of RBI, a a recent event.