Ind-AS increases provisioning pain for NBFCs amid Covid-19 pandemic

Covid-19 has led to lot of uncertainties including those pertaining to the income level of borrowers and hence, their loan repayment ability, savings habit, cash flow position of corporates

While there is little doubt that all lenders are facing the threat of higher credit risk because of the Covid-19 pandemic and the lockdown, some class of lenders, such non-banking financial companies (NBFCs), are expected to face even higher provisioning due to the relatively new accounting norm — Indian Accounting Standards (Ind-AS).

This is because provisioning under Ind-AS, known as expected credit loss (ECL), is ascertained based on the expectations of future credit losses, rather than incurred losses followed under GAAP (generally accepted accounting principles). Ind-AS became applicable to NBFCs and asset reconstruction companies from April 1, 2019.

According to Charanjit Attra, partner at EY, “Covid-19 would significantly impact ECL assessment under Ind-AS as lenders would now have to change their assumptions of default probability; the value of collateral is getting affected.” ECL is based on two key parameters — probability of default and loss given default (actual loss if the default occurs). The latter is also a function of the value of collateral.

 

 

Sai Venkateshwaran, partner and head, CFO Advisory at KPMG India, has similar views. 

“Considering the impact of Covid-19, the historic ECL methodology cannot be applied mechanically and NBFCs would need to make the best estimates based on past events, current conditions, and economic forecasts."

He expects the provisioning requirements under Ind-AS to be greater versus GAAP, as the ECL model requires lifetime losses to be recorded where there is a significant increase in credit risk. Lifetime loss is not only the current default amount but also all future payments receivable from the borrower.

Covid-19 has led to a lot of uncertainties, including those pertaining to the income level of borrowers and hence, their loan repayment ability, savings habit, cash flow position of corporates, etc, which NBFCs need to factor in while ascertaining future default probability.

 

 

“Though the regulator has given some respite through a moratorium, it is unlikely to eliminate lenders’ credit risk,” says Attra. In fact, for the accounts which have availed moratorium, IND-AS would warrant additional provisioning over and above 10 per cent requirement as the Reserve Bank of India, say some experts.

A likely deterioration in the collateral value would further inflate the ECL as the recovery in case of defaults could get impacted. According to a recent report by Motilal Oswal Securities, “The contraction in economic activity and its impact on consumers may have affected the value of collaterals and business cash flows, thus adversely affecting the expected amount of loss.” In fact, liquidation of assets would also become a tough task for lenders in the current scenario.

The degree of additional ECL, however, would vary across companies depending on various factors. 
 

For instance, parameters, such as degree of Covid-19 spread in different parts (of the country), borrowers’ profile, any change in their income levels, and resale value of collateral, are considered while deciding additional provisioning due to Covid-19, say V Ravi, executive director and CFO at Mahindra and Mahindra Financial Services. It would be making provisioning towards Covid-19, in addition to the ECL provisioning.

Even HDFC Bank, which announced its March 2020 quarter result on April 18, created contingent provisioning amid the Covid-19 pandemic. Although the markets are hoping that a stimulus package by government or regulator to provide some relief on this front, the jury is out.