Banks Governance Standards to Strengthen on RBI's NPL Guidelines

The Reserve Bank of India (RBI) has asked banks to make disclosures pertaining to divergence in the asset classification and provisioning a step towards improving governance and smoothening transition to IFRS9 (IND AS 109) says India Ratings and Research (Ind-Ra). The additional disclosure requirements for banks would compel banks to tighten their internal non-performing loans (NPL's) recognition and provisioning norms, thereby improving the overall quality of disclosures and provide a platform for more uniform recognition of stressed assets as non-performing across different banks.

Ind-Ra believes the journey towards enhanced governance structure started last year with the clean-up exercise by the RBI in the form of the Asset Quality Review (AQR), where a significant proportion of the unrecognized stressed assets in the system got reclassified which led to a sharp jump in NPLs. Also, in some way, the quantum of divergence would highlight the level of banks proactive governance initiatives and effectively enhances the importance of RBI's assessment from being descriptive to prescriptive. The disclosure norms for divergences enhances the accountability on the banks part to be compliant with the norms. Any sharp divergence is likely to be questioned by the stakeholders.

The requirement for boards of banks to proactively assess risks across sectors and make provisions above the minimum regulatory standards, starting with the telecom sector are intended to strengthen the banks' balance sheet for possible shocks on account of deterioration in asset quality. These provisions are also in-line with the migration to IFRS -9 (IND AS 109). This migration is slated to take place from the next year, but the proforma numbers will be released from June 2017 quarter onwards. The new accounting standards would require provisioning based on expected loss replacing the current incurred loss provision.

The blanket higher provisioning however generally seems to have been prescribed for meeting a larger objective and is not necessarily limited to credit risk. The RBI has prescribed higher risk weights for telecom, real estate lending, unhedged foreign exposure, capital market exposure among others. The provisioning enhancement on sectoral exposures in anticipation of credit losses may bring in subjectivity and may achieve the objective only partially. However, Ind-Ra notes that the notification is more in the nature of an advisory for the board and put the onus on them to be cautious and pro-active in terms of identifying the risk that could be building up in specific sectors, especially considering that there may be few large exposures residing and any slippage can impact the banks' buffer materially.

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