Reported by: banking|Updated: September 12, 2018
The Reserve Bank of India (RBI) announced the deferred implementation of IFRS9 equivalent, IndAS109 for all banks in India until 1 April 2019. This gives banks an additional year to prepare themselves for the application of IndAS109. IFRS9 was adopted internationally in 2017, and it was designed to set forth the accounting treatment for financial instruments. Banks in India now have the opportunity to learn the worldwide implementation. IFRS companies have recently published their 2017 accounts. The findings, as per the publications, show the restatements on transition and of the new accounting policies that need revisions.
Some of the significant implications of the new standard from its international exposure are:
Creating clearer balance sheets
The impact of IndAS109 on banks will be highly significant, given the prevalence and scale of the financial instruments in their balance sheets. IndAS109 is set to affect every financial sector, since the use of financial instruments is not just limited to banks but is extended to trade debtors and creditors, cash, loans, investments, etc.
IndAS109 has a clear categorisation that links the accounting treatment to the necessities of implementing the instrument. There is an amortised cost category that is to be used when the cash flows include payment only of the principal and interest (SPPI), and the business model is to hold the item to gather those cash flows. This will not only apply to the loans and collectibles from customers in banks but also to the trade debtors of other corporates.
The other central division will be fair value via profit or loss that is for trading or investment items; here, they are mostly held for disposal – primarily for banks. Although corporates may hold equity shareholdings for strategic business reasons, these will have to be at fair value. If pieces are held to accumulate those cash flows or perhaps for sale and they meet the SPPI test, they should also be at fair value with variations via Other Comprehensive Income (OCI). This just means that the income statement will be presented at a historical amortised cost, but the balance sheet will continue to exist at fair value. Such practice seems like the best representation for investments in bonds that banks may hold to provide liquidity if needed.
The most significant impact of IndAS109 for banks is likely to be the change in the calculation of requirements against loan loss and the higher level of them. IndAS109 uses an expected loss model which inevitably includes more forward-looking information.
All loans will cover both losses, which have already occurred, and the effect of events anticipated over the next 12 months. In case of significant credit deterioration, the full lifetime losses have to be provided immediately. For banks with more extended loans, the step-up from 12 months to lifetime can be highly significant in the amounts to be set aside. For other conglomerates, their trade receivables are relatively short-term, and therefore, the situation will be slightly different here.
Making the loan loss provisions more forward-looking and the impact of moving debt portfolios from 12 months to lifetime expected losses could make future reported earnings from banks more volatile as economic forecasts change. We will have to exercise patience and see the extent to which that will happen.
On equity holdings, the full fair value stock market revisions will impact profits in each period, except if the option is taken to treat the holding gains and losses throughout OCI.
Policy judgements and systems needed
Between today and April 2019, banks will have to finalise policies to deal with the intricacies of IndAS109 and implement systems to help with the required information. Different instruments are required to categorise business models – whether they qualify as SPPI or not. Expected loan losses cover forecasts of the future economic position. The meaning of significant credit deterioration needs to be formalised. While making provisions, probability-weighted estimates of cash flow on reasonably supportable bases and discounted at the original effective interest rate should be considered.
European banks (EU) stress upon the significance of the required judgements, complexity and extent of the system changes essential and time that these have taken to put in place. Indian banks should take note of this.
Training and understanding
IndAS109 is undoubtedly a sophisticated tool, and only a handful of its complexities have been observed in this article. Therefore, the need for a better understanding of it by different departments in a bank is needed. More importantly, a clear understanding of IndAS109 is necessary by the higher management who will be responsible for ensuring adherence to the policies and comment on the implications. Clarity on IndAS109 is also essential for the external parties – credit rating agencies, regulators and investors. Most EU banks have shared their experience with IFRS; however, some banks such as Unicredit and Deutsche Bank have opted to publish detailed statements of the impact.
Richard Martin is head of Corporate Reporting, Association of Chartered Certified Accountants (ACCA)