Will banks rise to the challenges ahead?

For the past two years, two things have been bothering bankers — credit growth and non-performing asserts (NPAs). This apart, the impending implementation of the revised accounting standards namely, Ind AS, and the newly introduced Goods and Services Tax all pose a challenge for heads of banks. Issues related to credit growth and NPAs have been widely discussed; let’s see how Ind AS and GST impact banks.

According to a notification from the ministry of corporate affairs, banks must comply with the new Indian Accounting Standards (Ind AS) for all financial statements for the accounting year beginning April 1, 2018. Once Ind AS comes into force banks will incur additional costs on account of the revised accounting methods. The concept of Expected Credit Loss (ECL) provided in Ind AS is significantly different from the current practice in which impairment is recognised on ‘incurred loss’ basis.

Computation of ECL is purely empirical and Ind AS has given broad guidelines to arrive at the ‘final rate’ of ECL for every segment of the credit portfolio such as corporate, MSMEs, agriculture, etc. This will be done through a migration study of their slippage from SMA-0 (special mention account) to Loss Assets.

Under the existing IRAC (Income Recognition and Asset Classification) norms of the RBI, banks have to mark a loan account as an NPA if the instalment or interest is 90 days overdue. Provisioning is based on the ‘past due’ concept. Under Ind AS, banks cannot afford to wait for 90 days and the ECL formula will accelerate the loss recognition early.

According to the existing accounting system, loan processing fees, irrespective of the term of the loan, are recognised upfront in the P&L account. Under Ind AS, if term loan is issued for a tenor of five years, the fees collected have to be amortised over the period of five years using the effective interest rate method.

Banks’ investments in government securities are presently kept in the books of account under three categories, namely, held for trading (HFT), available for sale (AFS), and held to maturity (HTM). Any fall in the price of bonds kept in HTM need not be recognised. Also, shifting of securities from/to HTM is possible in a year.

All these classifications will go away in Ind AS and investments will be measured at ‘fair value’ (market value) on the reporting date. This change will have a direct impact on the P&L account of banks. Further, the treasury departments of banks will also be denied the flexibility presently available to them to churn the portfolio to the bank’s best advantage.

The treatment of certain financial instruments in Ind AS is likely to impact some financial ratios and thus the process of banks’ credit appraisal. Ind AS prescribes that a financial instrument that has a contractual obligation to the issuer to deliver cash to the holder must be treated as liability and not equity. Thus redeemable or convertible preference shares are to be treated as liability. These differing treatments of financial instruments would vary financial ratios such as debt-equity and EPS.

Disturbingly, all loans given to staff members at a concessional rate are to be treated at ‘fair value’ and the attendant loss has to be booked in the accounting system of Ind AS. For example, if the housing loan interest rate of a bank is 9 per cent pa and for the staff it is issued at 6 per cent pa, then the differential of 3 per cent has to be treated as hidden loss and has to be recognised in its P&L account!

Operative guidelines with regard to Ind As are awaited from the RBI. One hopes that they would provide more clarity on some complex provisions and also soften a few so that banks do not take a big hit. Anyway, in the present context, Ind AS will be harsh on banks though it aims to bring out the fair value of every asset.

While there is no denying the fact that the transformation to GST is a welcome feature and will be beneficial in the long run, the initial hiccups are likely to cause hardship; given the current level of preparedness, it seems the teething troubles may extend beyond six months.

Excepting the interest charged on loans and advances, almost all other incomes such as commission on bank guarantees/letters of credit, loan processing fees, commission on fund transfers and locker rents will attract GST. Therefore the existing software of banks has to be suitably modified to process this additional tax. Because of the possible huge rise in number of transactions, banks have to ensure that it does not result in scalability issues. Further, at a time when there is already a hue and cry over the charges, how they could pass on this additional burden to customers is also a big question mark.

The GSTIN of all customers who have registered themselves under GST has to be obtained and fed into the system by banks, otherwise the input credit will not be made available to them. The segregation of registered and unregistered suppliers (of goods and services) have to be done by banks, or else the compilation of returns will become complex and difficult.

The bottom line of banks will also be hit on account of GST. Every supplier of goods and services with an annual turnover exceeding ₹20 lakh has to necessarily register himself in the State where he is making the supply. It is possible that branches of many banks will be housed in the premises of owners with turnover below the said threshold limit and therefore could remain unregistered. In such cases also the input credit for 50 per cent GST on the rent will not be available to banks, unlike how it was in the service tax regime.

For example, if a bank pays a monthly rent of ₹3 lakh for one of its branches in Chennai and the building owner happens not to be registered under GST, the bank has to pay 18 per cent GST, that is, ₹54,000; it can adjust only 50 per cent of it (₹27,000) from the GST payable. The balance has to be treated as expenditure to be borne by the bank.

GST does not come in the way of banks giving concessions to customers or staff members by way of interest rates and other charges. Unfortunately the Government is not prepared to make any sacrifices. Therefore, whatever the GST applicable for the concessions given, banks are obligated to remit the same. It is GST for the forgone income.

To sum up, banks are confronted with both business issues and compliance (regulatory/ mandatory) issues. Both for Ind AS and GST, banks have to install the appropriate software to accommodate the respective requirements.

Truly, it is a testing time for banks. They must hasten to harness all their marketing talents and technological skills to navigate and overcome this quagmire.

The writer is the director of City Union Bank. The views are personal