While Indian Banks will converge towards IND-AS (IFRS) with effect from 1 April 2018 onwards. Some of them already started taking action to make their books in line with the requirements of IND-AS.
There are many areas where Banks needs to work upon. However, in this article we will touch upon some potential changes/ differences where regulator and the Standard setters need to provide more clarity in order to make all such accounting treatments consistent across Industry.
Many Banks including Indian banks use write-offs of loans as one of the measure to clean their books and improve assets quality and that also increase return on assets also. An Industry expert made a comment about these “written off of loans by Banks” in which he said most of the write-offs are being done for big loans only and not for retail portfolios.
First, we look at the real meaning of write-offs and see how it is being done/ handled in India before we adopt IND-AS.
When a Bank do write-offs it does not mean that it has given the borrower a clean chit and assumed the loss on that loan in its books. Hence, it is very clear that even though the loan is being removed/ cleaned from the books of Bank, it remains in the records of the Bank and borrower needs to pay the same as it has contracted with the Bank.
Under the current accounting practice the loans can be written off from the books of the banks as per the approval from credit committee of the bank (subject to limits as prescribed) and by issuing subsequent instructions from the Head office of the Bank, such loans can be removed from the books of the banks. However, as per the RBI circular, all these write-offs are to be disclosed properly in the books of account of the banks with the respective movements in amounts.
Example policy on Write-offs by one of Indian bank (extracted from “ICICI Bank” annual report):
Policy in relation to write-offs:
The Bank considers exposure for write off when the prospect of recovery over the next 12 month is remote and interest has not been serviced for the past 12 months. Any amount written off is in the first instance applied against specific provision for the exposure. In the normal course of business the loss to be written off will already have been fully provided. Any decision for a write-off is approved by the Board Credit Committee of the Bank.
As per forthcoming requirement under IND-AS 109- Financial Instruments:
As per Ind-AS 109 - “Financial Instruments” para 5.4.4 states that an entity shall directly reduce the gross carrying amount of a financial asset when the entity has no reasonable expectations of recovering a financial asset in its entirety or a portion thereof.
Further, it says “An entity has no reasonable expectations of recovering the contractual cash flows on a financial asset in its entirety or a portion thereof.
Now, there are some issues which are be dealt in due course in order to make this transitional changes in accounting systems as the new requirement brings more stringent rules which were not very similar in the current practice within the Industry -
1. The standard uses the words “no reasonable expectation of recovering a financial assets” which is very judgmental in nature and unlike in current practice it cannot be established very easily before it gets approved from the credit committee, hence there would be required to present all sort of documents which can state that there is no more reasonable expectation of recovery hence it is recommending for write-off.
2. There would always be some kind of collateral which is being kept by the borrower, hence now there are two ways to look at it, first is if the security has been realized already and there is no more expectation to receive any cash flow then the loan should completely by derecognized from the books. However, if there is some collateral which is to be realized to recover debt then the expectation should be built in order to continue with the asset in the books.
3. Further after realizing the collateral etc, if there is still some expectations that is being built to recover cash flow, then that asset can not be written off fully (may be partial write-off can be done) and one needs to understand the expectation towards the cash flows to come in.
4. Usually when a bank stops asking any claim/ repayment towards the loan then only that asset should be written off.
5. When there are many reasons to believe for reasonable expectations towards the cash flows then it will be difficult to write-off such loans/ assets from the books of bank.
These are few pointers that could be argued and one has to deal in detail while re-drafting a policy/ processes for bank write-off systems. Also, regulator has to come up with the clarity on the use of technical write-offs Vs. Write off as applicable by IND-AS 109.