ANALYSIS For IndusInd Bank, MFI issues are larger than derivative woes

While provisioning for the quarter ending March 31, 2025, increased significantly to over Rs 2,000 crore, largely on account of accounting adjustments for microfinance business, most of the other adjustments have been done within items of the profit and loss (P&L) statement, such as moving some portion of interest income to other income and so on.

What is noteworthy is that the impact of microfinance-related issues appear to be larger than the losses caused by improper accounting of derivatives.

As a result, almost each of the heads of income and expenses seem to have been impacted by the restatement of accounts. Consider for instance interest income. It saw an overall impact
of Rs 1,368 crore in the March quarter due to the incorrect recording of cumulative interest in the microfinance business and on account of other income being wrongly classified as interest income.

This issue was highlighted when the bank’s internal audit department discovered that Rs 172.58 crore had been incorrectly recorded as fee income in the microfinance business over three quarters ending December 2024, which was subsequently reversed in the fourth quarter of FY25.

Microfinance impact

What is more significant in the microfinance business is the quantum of provisions and contingencies made during the quarter.

This stood at Rs 2,522 crore, of which Rs 1,791 crore relates to provision on account of reclassification (or downgrading) of microfinance loans, classified earlier as standard assets, to
non-performing assets (NPAs) after the review by the bank’s internal audit department.

The review led to 95 percent of such assets being reclassified. This has resulted in an additional NPA of Rs 1,885.19 crore from the MFI business, as reported by the bank.

The bank also appears to have recognised microfinance loans that were previously misclassified or underreported and subsequently downgraded a significant portion of them as NPAs.

During an analyst call on May 22, the bank’s management explained: “There were certain items that were part of the fee income from the beginning but were wrongly classified under interest income. We have now reviewed the overall grouping and classification. Based on that, we have regrouped them under the correct heading. There has been no impact on the P&L as such; however, the classification within the P&L has changed. That is the correction we have made overall.”

However, when a few analysts sought details on how these adjustments were made, the management referred to the notes to accounts and responded that these questions could be taken
offline.

Derivatives accounting

The incorrect accounting on certain derivatives transactions — the episode that triggered the investigations leading to the exit of key managerial persons — has been quantified at Rs 1,959
crore.

This amount has been written off as a prior period item in the current financial year, though it pertains to the period between FY16 and FY24, as per the audit report. Therefore, it
has a direct bearing on the bank’s net worth rather than on the profit and loss (P&L) statement.

Nonetheless, a combination of inter-head adjustments, restatement of financials, prior period adjustments and massive provisions, taken largely towards the microfinance business, has led to a net loss of Rs 2,328.92 crore for Q4 FY25. This is the largest in its three-decade history, with gross
NPAs rising to over three percent.

During the investor call, when asked whether the bank has taken all the necessary adjustments to its financials in Q4, the response was: “Some of those one-offs, such as interest reversals, have been allocated to the respective underlying businesses.”

According to the management’s calculations, if the bank excluded all the interred items, adjustments, and one-offs, net interest income would be around Rs 4,700 crore. The non-
interest income would be approximately Rs 2,500 crore, and the operating profit would be around Rs 3,060 crore.

Overall impact

The overall impact of these items on the profitability and net worth of the bank, mainly on reclassification of financials, amounts to roughly about Rs 4,975 crore. It can be split into
Rs 1,959 crore, written off as prior period adjustment for derivatives-related issues, and Rs 3,016 crore, largely related to reclassification and provisioning in the microfinance portfolio.

Also, the auditors of the bank have noted that the suspected offences -- the lapses in derivatives accounting and in microfinance business -- may involve fraud. This confirms Moneycontrol’s report on May 16, which said the Reserve Bank of India (RBI) is thinking on the lines of tagging
the lapses in the bank as fraud.

On March 10, 2025, IndusInd Bank disclosed to stock exchanges that an internal review of its derivatives portfolio identified discrepancies in accounting practices, particularly related to foreign exchange derivatives transactions.

The internal review showed that the hit on account of derivatives lapses is about Rs 1,959 crore, similar to the guidance provided by the bank’s former CEO Sumant Kathpalia.

Subsequently, a review by an external agency in the nature of a forensic audit confirmed the finding of internal review done on the treasury side. Meanwhile, the bank’s internal audit team has also flagged off several accounting and procedural lapses in the bank’s microfinance loan book