The Hindu Business Line : A unique environment

Restructuring, rescheduling and delayed repayments are considered par for the course today. Auditors too are getting prepared to face this challenge.

Mohan R. Lavi

John Paul Getty said, “If you owe the bank $100 it’s your problem, if you owe the bank $100 million it’s the bank’s problem.” Banks, traditionally considered as aiding in making the economy productive by lending and keeping funds, are at the crossroads today. The toxic instruments of financial destruction that commenced in the US spread their tentacles globally, and the recession has ensured that borrowers have less money in the kitty to repa y loans.

Restructuring, rescheduling and delayed repayments are considered par for the course today. With the date for banks to close their annual accounts just about over, the Reserve Bank of India (RBI) has been busy educating banks as to what they should do about assets that may defy the definition of assets in the future. Auditors too are getting prepared for audits in an environment that is unique and challenging.

Specific provisions

Probably taking a cue from the concept of fair value — much recommended by the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) — a recent Circular dated March 25, 2009, encourages banks to voluntarily make specific provisions for NPAs at rates which are higher than those prescribed under existing regulations if such higher rates are based on a policy approved by the board of directors to provide for estimated actual loss in collectible amount and the policy is consistently adopted from year to year.

It states that provisions for diminution of fair value of restructured advances, both in respect of standard assets as well as NPAs, made on account of reduction in rate of interest and/or reschedulement of principal amount are permitted to be netted from the relative asset.

If the sale is in respect of standard asset and the sale consideration is higher than the book value, the excess provisions may be credited to profit and loss (P&L) account. Excess provisions which arise on sale of NPAs can be admitted as Tier II capital subject to the overall ceiling of 1.25 per cent of total risk weighted assets.

The RBI also recommends that while floating provisions cannot be netted from gross NPAs to arrive at net NPAs, it is clarified that they could be reckoned as part of Tier II capital subject to the overall ceiling of 1.25 per cent of total risk weighted assets.

The statement of financial position of many banks is expected to be slightly skewed this year while fair value provisions would ensure that there are some interesting entries in the income statement also. There has already been some diatribe from the Institute of Chartered Accountants of India (ICAI) to a beneficial circular issued by the RBI on restructured assets.

Revised Fair Value

There could however been some changes internationally to the concept of fair value and accounting standards. The G-20 and other international bodies have called for standard-setters to seek global solutions to a global crisis and a Financial Crisis Advisory Group (FCAG) has been set up to advice on these matters.

Both the FASB and the IASB have joined hands to work towards common standards that deal with off-balance-sheet activity and the accounting for financial instruments. Furthermore, the boards have agreed to issue proposals to replace their respective financial instruments standards with a common standard in a matter of months.

As part of this project the boards will examine loan loss accounting, including the incurred and expected loss models, financial statement presentation, fair value measurement, financial instruments with the characteristics of equity and the conceptual framework.

These should be of interest to banks since they would be the most impacted in applying fair value norms to financial instruments they hold.

While one cannot wish away fair value as being unfair, the timing of its introduction makes it a villain. While one certainly cannot expect historical cost to be reinstated, a toned-down version of fair value is certainly on the anvil.

(The author is a Hyderabad-based chartered accountant.)

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