Ind AS for NBFCs – Not Just an Accounting Challenge

Indian Accounting Standards (Ind AS) have become mandatory for certain non-banking finance companies (NBFCs) effective April 1, 2018, with the first quarter reporting out for some. This puts to rest the speculation that the transition to Ind AS for NBFCs may get postponed. Transition to Ind AS, while primarily being an accounting change, is expected to have a profound impact on the business of NBFCs. Ind AS should be as much part of the CEO agenda as it is of the CFO/ Controller’s agenda as it is expected to significantly alter the KPIs and business ratios (cost-to-income ratio, NII, NIM, NPA ratios and provision coverage ratios) based on the choices made. NBFCs are advised to proactively reach out to internal and external stakeholders to highlight impacts of these changes.

Some of the significant potential changes in practices that are expected due to Ind AS are as follows:

• Upfront fees and loan origination costs such as commission and incentives are incurred by NBFCs. Ind AS requires amortisation of these directly attributable and incremental origination fees and costs.

• Generally, costs that are incurred in-house are not eligible for amortisation, this makes the choice of the operating model, i.e., insourcing vs outsourcing, relevant in the way these costs impact the statement of profit and loss.

• One of the key changes in impairment provision is consideration around Expected Credit Losses ‘ECL’ from the current delinquencybased provision. In case NBFCs do not embed concepts like risk-based measures for pricing of loans and asset allocation, then there would be a direct impact in the statement of profit and loss account.

• For assets where there had been significant increase in credit risks since origination (Stage 2), i.e. when the facility is more than 30 days overdue, Ind AS requires recognition of lifetime ECL as against 12 months ECL (Stage1). This will create a cliff effect and will tantamount to a high impairment charge being recognised upfront. Hence, NBFCs may now need to spend greater effort on early collections so as to avoid recognition of life-time provisions.

• Employee stock options will also impact NBFCs, as Ind AS mandates fair valuation of these options to be recognized as a charge in the statement of profit and loss, as against not recognising any charge in the erstwhile Indian GAAP. The critical part of Ind AS implementation requires clarification in the existing RBI Master Circulars. In the absence of any implementation guidance, the accounting of certain transactions will have to be on the basis of the Ind AS framework. This might have far reaching consequences. For example:

• Several NBFCs frequently enter into secularisation and direct assignment transactions. The assessment of whether significant risks and rewards have been transferred to the purchaser or the secularisation trust is different under Ind AS when compared to Indian GAAP. This results into the loans being recognised back on the books of the originator and in other cases loans may need to be fair valued.

• Compulsorily convertible preference shares are eligible for consideration as Tier 1 capital under the RBI regulations. Ind AS, however, would require the assessment of the terms of conversion and certain instruments would not be eligible to be considered as an equity instrument impacting Tier I capital ratio.

• NBFCs are required to submit periodic returns to the RBI, however it is still unclear as to whether these returns would be prepared under the erstwhile Indian GAAP or under Ind AS. While a harmonious approach would be to align the financial reporting and regulatory reporting, it is a significant area where clarification is still to be received from RBI.

• The treatment of Ind AS transition adjustments on capital adequacy is also unclear, since there could be instances wherein the transition adjustments have a significant impact on the net worth of NBFCs on transition. The current environment where Ind AS transition is being conducted has considerable ambiguity due to the lack of certain key regulatory clarifications and guidance.

Making business decisions in such an environment may prove to be challenging. The NBFC industry will look forward to receiving inputs from the regulators like the RBI to help companies achieve a smoother transition for both financial and regulatory reporting.

The Economic Times, 21st August 2018

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