In the first week of April 2018, the Reserve Bank of India (RBI) issued a press release deferring the implementation of Indian Accounting Standards (Ind AS) for banks by one year to 1 April 2019. Now, in March 2019, the question is back on the minds of all banks and their stakeholders – will Ind AS be deferred yet again?
Prior to this deferral, scheduled commercial banks (SCBs), excluding regional rural banks (RRBs), based on RBI’s circular of February 2016, were expected to adopt Ind AS from 1 April 2018 with comparatives for the prior year. As per RBI’s press release, certain legislative amendments to the Third Schedule to the Banking Regulation Act 1949 were under consideration of the government to make the format of the financial statements prescribed therein compatible with the requirements under Ind AS.
The press release also referred to the level of preparedness of banks to make this transition. Further, it was expected that the RBI would issue operational and other guidelines, including those relating to prudential norms to enable implementation of Ind AS by banks.
However, almost a year later, it doesn’t appear that the needle has moved on any of these issues—the legislative amendments to the Banking Regulation Act, the guidelines to be issued by RBI or the overall preparedness of banks. Therefore, it almost appears that a further deferral of the implementation date is inevitable.
It should also be noted that non-banking financial companies (NBFCs) have already transitioned to Ind AS and are still awaiting clarity on several operational guidelines.
What does it entail for the banks and why is this important?
Ind AS are converged with International Financial Reporting Standards (IFRS) and, therefore, expected to enhance the transparency and comparability of the financial statements of Indian banks with their global counterparts. The adoption of Ind AS is expected to have a pervasive impact on banks, impacting not just accounting and disclosures, but also includes their business practices, systems and processes, regulatory reporting and capital adequacy etc.
Ind AS would also require early recognition of a provision for losses on loans and off-balance sheet exposures based on an expected credit loss (ECL) model, which brings in forward-looking information and macroeconomic factors in the estimation of losses. Banks in other parts of the world following IFRS have adopted the ECL model in 2018 and there has been an increase in the loan loss provisions, although not very significant, partly due to the benign economic and business environment prevailing in other parts of the world. However, considering the situation in India, this could potentially increase the extent of loan loss provisions and therefore increase the capital requirements of these banks.
The timing of adoption of Ind AS by banks also coincides with the introduction of Ind AS 115 on revenue recognition and Ind AS 116 on leases. These are also expected to impact the timing of revenue recognition by banks and also bring on several off-balance sheet leasing arrangements on to the books.
Considering the impact that all of this has on a bank’s internal systems and processes and taking into account the level of progress made by most banks, there is a lot of ground to be covered by banks before they can adopt Ind AS.
Impact on regulatory reporting
One of the other reasons that may have a bearing on the deferral of Ind AS is the impact that this transition has on regulatory reporting and capital adequacy of banks. While this is a valid concern, especially in light of the stress in the banking system due to the extent of non-performing assets (NPAs), there may be ways that RBI can adopt to make the accounting transition easier vis-à-vis the corresponding regulatory reporting requirements.
In this context, it is worthwhile to note that the Basel Committee, in light of the global adoption of IFRS 9 and the ECL model for provisions, has decided to retain, for an interim period, the current regulatory treatment of provisions and also introduce transitional arrangements to smoothen any potential significant negative impact on regulatory capital arising as a result of ECL accounting.
As per these Basel Committee guidelines, regulatory authorities in each jurisdiction can provide guidance on how they intend to categorise ECL provisions as specific or general in calculating regulatory capital requirements. Further, as per the transitional arrangements, which can be applied to all ‘additional’ provisions arising as a result of the adoption of ECL accounting, the additional impact can be absorbed over a period not exceeding five years on a straight line method.
RBI should certainly consider adopting these transitions and interim regulatory treatments as and when banks in India migrate to Ind AS, thereby minimising the impact on regulatory reporting.
Considering the impact of this transition on the banking sector and the time required to get ready, RBI needs to issue the operational and other guidelines for both banks and NBFCs so as to enable them to make the transition to Ind AS. RBI should also take into account the interim regulatory treatment and transition guidelines issued by the Basel Committee to ensure a smooth implementation for this very important sector. Banks on their part should also quicken their efforts to get their technology, systems and processes aligned to the new requirements.The author is Partner and Head, CFO Advisory, KPMG in India. Views are personal.