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IFRS: Perspectives fromthe Indian banking sector



for

On 29 March 2010, the Ministry of Corporate Affairs (MCA)nalized the roadmap for the convergence of the Indian

Accounting Standards with International Financial ReportingStandards (IFRS) with respect to insurance companies,

banking companies and non-banking nance companies.The roadmap requires all scheduled commercial banks toconvert their opening balance sheets as at 1 April 2013. Thiscontrasts with companies in other sectors, the rst tranche ofwhich must convert their opening balance sheets as at1 April 2011.

The industry that is most affected by the adoption of IFRSin India is the banking industry. In India, banking is heavily

regulated and the generally accepted accounting principlesas issued by the ICAI for companies are superseded in anumber of key areas (for example investments) by accountingprinciples and prudential norms issued by the sector regulator,viz., the Reserve Bank of India (RBI). The conversion challengefor the sector is compounded since the main standard ofconcern, IAS39, is being replaced with a new standard, IFRS9,in three phases:

• Recognition and measurement• Impairment• Hedge accounting

This was one of the primary reasons cited by the RBI inobtaining an extended roadmap of 2013 for the sector.

Keeping in mind complexities associated with the IFRSstandards, particularly in light of requirements peculiar toIndia (for example, Statutory Liquidity Ratio securities),

the assessment of the impact on the banking sector prior



eword

to implementation was considered critical and, therefore,included as an item within the 2010–11 RBI Annual Policystatement. As a result, the RBI has formed a working groupto understand IFRS implications for the sector although no

of cial guidelines have been issued as of yet.

Ernst & Young has conducted a survey across the bankingindustry on IFRS. The objective of this survey is to get aperspective of the key IFRS implementation challenges andissues as perceived by the banking sector as well as channelthe feedback received into the various policy making initiativesthat are currently in progress.

In our experience, IFRS implementation in a bank wouldtypically require the involvement of a number of departmentsoutside of the core nancial reporting function (for example:treasury, risk management, information technology andmanagement reporting, among others). Therefore, as far aspossible, we have obtained feedback from relevant individualsat an appropriately strategic level, e.g., CFOs (or equivalents)as well as IFRS project managers (where appointed).

We are pleased to bring to you the results of the feedback

received from 20 banks we had reached out to representingalmost 60% of the banking sector (by asset size). The coverageis well spread across the banking spectrum of the publicsector (seven banks), private sector (seven banks) and foreignbanks (six banks). We thank the participants for their strong,insightful and candid responses. We trust that you will ndan interesting snapshot of the current state of play for thisstrategic sector in the proceeding pages.



IFRS: Perspectives from the Indian banking sector1 |

1. Apart from the statutory requirementwhat level of bene t do you perceivefor your organization in implementingIFRS?

Almost all the banks surveyed perceivedsigni cant to moderate bene ts inimplementing IFRS. The two principal reasonscited were:

i. Greater ease in being able to raise capitalor funds in other jurisdictions

ii. Comparability with global peers

One of the CFO’s surveyed expressed thatthey could have received a more favourablerating if IFRS accounts had been prepared.

The results re ect broad industry support foradopting a globally accepted set of accountingstandards. Equally important, the resultsappear to emphasize a strong preferencefrom the industry that the deviation from

IFRS principles and requirements should beminimal, while implementing the convergedstandards (IND-AS) in India.

2. How high a priority as a project do youperceive the convergence to IFRS (IND-AS) to be for your organization?

The majority of the banks surveyedperceive the IFRS (IND-AS) convergenceprocess as a moderate-to-high priority

project, with primary drivers being thepervasive impact of the standards as well ascomplexities associated in a pan-organizationimplementation. For example, a largepublic sector bank commented that any ITmodi cations and training would have to berolled across 1,000+ branches.

A number of banks cited the 2013–14implementation date as the reason for amoderate classi cation at the present time,but did suggest that their expectation ofa change in priority status closer to thedeadline.

Some benets45%

Signicant benets45%

No benets10%

Low26%

Moderately High52%

Very High22%



IFRS: Perspectives from the Indian banking sector | 2

A number of foreign banks gave a low prioritystatus to the IFRS convergence project,which is perhaps re ective of the fact thata number of these entities already report totheir parents abroad under IFRS/US GAAP.These banks would also have a comparativelyreduced scale of implementation challenges,given the signi cantly lower number ofbranches.

3. Will you be presenting comparatives,which would require a 1 April 2012transition date?

Under the current IND-AS 101 (correspondingto IFRS1) proposed requirements, thepresentation of a comparative periodis optional. While no guidelines orrecommendations have been issued by theRBI as yet, the presentation of comparativeswould effectively bring forward the transitiondate by a year, to 1 April 2012, for bankingentities if they elect to do so.

Understandably, a signi cant number ofentities have not yet decided on this topic.Indeed a number of them are looking toobtain direction from the RBI in this regard.Interestingly, a number of entities across the

banking spectrum have stated a preference

not to show comparatives if the optionexisted. There are two primary drivers ofsuch a view — one, there are no perceivedsigni cant bene ts at this point in timeand two, there is added pressure on theconvergence project by reducing thetime-frame.

Banking entities should, however, keep inmind that IFRS 1 requires the presentationof comparatives and, therefore, the non-disclosure of the same would result in the

inability to achieve dual compliance betweenIND-AS and IFRS, at least for the rst year.

No

32%

Not Decided50%

Yes

18%




4. How would you rate the dif culty ofconversion to IFRS (IND-AS) in speci careas on a scale of 1 to 5 (5 being themost dif cult)?

Area 1: Disclosures A majority of the banks surveyed gave a highrating with regards to disclosures as an areaof dif culty. One of the biggest practicalchallenges in implementing IFRS will becollection of the information that requires

disclosure. The level of rst-time effort for

disclosure requirements, especially withregard to nancial instruments (IFRS 7) fora banking entity, cannot be underestimated;particularly as the necessary information maynot be held directly in the accounting recordsbut instead may need to be sourced fromother areas.

One of the best ways to start may be totake each IFRS 7 requirement in turn, soas to determine whether it is already beingdisclosed or data is at least already internallyavailable within the existing systems andprocesses.

Area 2: DerivativesIn general, not many banks in Indiaoperate large trading desks with regardsto derivatives. Open derivative positionsare generally utilized for balance sheetmanagement purposes. Therefore, very fewbanks have a large derivative portfolio incomparison to their balance sheet size.

While a number of private and foreign bankshave a reasonable derivative portfolio,mark-to-market values through valuation

techniques are already obtained in most cases

5

10

13

0

29

10

26

13

10

19

30

9

33

52

17

57

24

10

13

22

Loans andadvances

Investments

Derivatives

Disclosures

Figures in %

Level 1 Level 2 Level 3Level 4 Level 5




and, as a result, derivatives are not perceivedto be an area raising signi cant challengesupon conversion to IFRS (IND-AS).

While hedge accounting is a complex areaof the IFRS standard, most banks have notconsidered utilizing this option at present.

Area 3: Investments

Investments is expected to be a critical areaimpacted by the conversion to IFRS (IND-AS).IFRS9 requires a business model to be createdfor assets to be classi ed at amortized costwhose objective must be to collect contractualcash ows. Although some sales are allowed,these are expected to be not more thaninfrequent.

The challenges are compounded as the Indianbanking sector must adhere to certain speci cprudential requirements (e.g. SLR securities).In addition, there is a lack of an active andliquid market for most debt securities and,therefore, transaction evidenced mark-to-market values are not readily available.

In light of the above, most of the respondents

gave a rating of 3 and above vis-à-vis theperceived dif culty of implementation forthis area.

Area 4: Loans and advancesLoans and advances are also expected tobe one of the critical areas upon conversionto IFRS (IND-AS). Some of the key topicsare effective interest rate, impairmentand application of IFRS9 requirements foramortized cost classi cation. The challengesfor implementation are expected to be greaterfor retail portfolios as opposed to large-ticketcorporate loan portfolios.

Understandably, a signi cant portion ofthe banks gave a rating of 3 or higherwith regards to the perceived dif culty ofconversion for this area.

A number of foreign banks gave a rating of2 and below for this area, perhaps re ectiveof the fact that a number of the entitiescurrently already report to their parentsabroad under IFRS/US GAAP.




5. What is your preparedness for reportingunder IFRS-converged standards(IND-AS) in India?

A majority of the banks surveyed are currentlyassessing the impact of IND-AS, whereas fewbanks are yet to start on their convergenceproject. There appear to be two major reasonsfor this state of play:

i. Banks are waiting for the nalization ofimpairment rules in IFRS9; and

ii. Many banks expect that the RBI will issuesupplemental guidance or carve-outs forcertain important areas such as accountingfor SLR securities and impairment

Indeed, a few of the surveyed banks who havenot yet started on their conversion project areexpecting a formal communication from RBIbefore starting on their IFRS project.

6. Do you think your bank has skilledresources for converging to IFRS(IND-AS)?

As expected, most of the banks plan totrain their existing resources in order to beprepared for reporting under IFRS. Onlyforeign banks who already report underIFRS for their group reporting have skilledresources and they will also need to train theirstaff on the forthcoming changes to IFRS.The recruitment of skilled resources for IFRS

remains a challenge, given the general lack ofstaff with the practical experience of reportingunder IFRS. While some banks have recentlyadded professionals in their nance teams,such additions were not a direct result of theIFRS projects.

Currently assessing theimpact of IND-AS

55%

Not started27%

Currentlydeveloping

solutions forIND-AS

18%

Train existing resources70%

Not sure0%

Yes22%

Recruit9%




The approach favored by the banks isconsistent with our experience in other

jurisdictions that have implemented IFRS.Banks recognize that they will need assistancefrom consultants on some of the verytechnical areas of convergence, e.g., nancialinstruments classi cation, calculation ofeffective interest rate, impairment models andaccounting for structured transactions.

However, they equally recognize theimportance for their own staff to beresponsible for the overall project to ensurethe following:

i. Adopting policies suitable to the bank

ii. Institutionalizing the IFRS knowledge

iii. Embedding the IFRS reporting as businessas usual for their staff

In-house withassistance onspecic issues

83%

Fullyoutsourced

0%

Completelyin-house

17%

7. How do you intend to run the IFRSconvergence (IND-AS) project atyour bank?

All surveyed banks, except for some foreignbanks, who already report under IFRS fortheir group reporting, plan to run their IFRSconversion project with assistance from anexternal consultant on speci c issues.




8. To what extent do you think your ITsystems will require modi cation foryour bank to move to IND-AS?

Almost all surveyed banks believe that themove to IND-AS would require moderate-to-signi cant changes to their IT systems. Themain areas that will impact the IT systemsinclude the application of effective interestrate (EIR) for nancial assets carried atamortized costs as well as the calculation ofimpairment losses.

Most core banking solutions calculate interest,based on the contractual rates and update the

nancial reporting system on the same basis.Upon conversion to IFRS, it is likely that aseparate application or an intermediate layerof software would be required to calculate

data for nancial reporting systems based onthe customer/contract data available in thecore banking solutions.

Similarly, new automated models thatinclude linkages between risk managementsystems and core banking solutions would be

Some awareness78%

None13%

High9%

necessary to calculate impairment losses. Riskmanagement systems would also need to beenhanced to provide data for all IFRS-required

nancial risk disclosures.

9. Outside of the nancial reportingfunction, what level of awareness onIFRS (IND-AS) would you perceiveexists across your organization?

IFRS (IND-AS) implementation for the

banking sector is expected to require supportfrom a number of departments outsidethe core nancial reporting function. Forexample, business models for amortizedcost classi cation must be determined bythe entities’ key management personnel andpresumably would require requisite policiesand processes to be updated for the TreasuryDepartment. Another signi cantly impacted0%

10%

20%

30%

40%

50%

60%

Signi cantchange change changeModerate Little Nochange Don’tknow




function is the Credit Department(s) of abanking entity as a large number of corporate

entities in India will be converging from 1April 2011 and, therefore, the understandingof the balance sheets of such corporates inthe new regime will be critical. Further, riskmanagement and IT departments are alsoexpected to play enhanced roles for a bank tobe able to implement and produce IFRS(IND-AS) compliant nancial reports.

The majority of the players in the bankingsector have stated that there is some level ofawareness within the organization. However,a number of entities voiced concerns that thelevel of knowledge and understanding maynot be adequate.

0% 10% 20% 30% 40% 50%

Lack of Regulatory Guidance

Evolving Standards

Lack of support f rom otherdepartments

Prohibitive cost

Lack of skilled resources

10. According to you, which of the followingrepresents the most signi cant hurdle

to converge to IFRS (IND-AS)?Understandably, the lack of regulatoryguidance and evolving standards are seen bythe Bank as main hurdles to their convergencewith IFRS. There has been very little formalguidance from RBI since the announcementof the IFRS roadmap for the bank. Several ofthe banks surveyed remain skeptical that the

RBI will remove all of its current accountingrequirements, including for areas such as loanimpairment.

There is an equal amount of concern amongbanks about the fact that revised IFRSstandards for certain key areas such as




nancial instruments, revenue recognitionand consolidation are currently at variousstages of drafting. Further, banks are alsoconcerned about the uncertainty over howand when the changes will be adopted in IND-AS. The main factor for concern is that thetiming of the nal standards may not leavesuf cient time for banks to transition by1 April 2013.

A small portion of the banks consider thelack of skilled resources and the lack ofsupport from other departments, particularlyconsidering that several other projects suchas the Basel II advanced approach, are beingimplemented at the same time, as the mostsigni cant challenge.

Interestingly, while banks recognize that therecould be signi cant costs associated with theconvergence projects, none of the surveyed

banks consider that as a signi cant hurdle.




11. As IFRS is principles-based, what kindof regulatory direction on accountingwould you prefer upon convergencein India?

Prescriptive on select issuese.g. impairment

48%

Prudential only26%

Comprehensiveguidance

26%

Most of the banks surveyed prefer to continuegetting guidance from the regulator onaccounting matters to ensure consistencyand comparability across the sector. Themajority of the banks would prefer that thefuture prescriptive regulatory guidance onaccounting is limited to only select issues, andin particular, for loan impairment.

Interestingly, this approach is the mostfavored among the nationalized bankssurveyed, whereas the private and foreignbanks surveyed are split across thethree options.

The foreign banks that already report IFRSresults for group reporting understandablyprefer to align their local reporting with thegroup reporting. They want RBI guidelines tobe limited only to prudential reporting.



con

The survey results bring out a number of interestingobservations. While there appears to be strong pan-industrysupport for converging with IFRS, a large part of the sectorhas voiced a preference for guidance on certain critical areas,

e.g., impairment.

In line with the sentiments of the banks, the RBI has recentlyset up a working group to develop operational guidanceon speci c matters related to IFRS. However, it would bea challenging task to provide a t-for-all comprehensiveor prescriptive guidance as application of several IFRSprinciples, e.g., the determination of business models forinvestment classi cation can differ signi cantly, based on

the facts and circumstances for each bank. Therefore, theRBI will have to walk a tightrope to ensure that its guidelinespromote consistency and comparability amongst banks, whileremaining within the overall IFRS framework.

While many of the largest players in the sector have alreadybegun the conversion process, it is interesting to note that asigni cant number of players have not yet commenced, withthe primary reasons being the evolving standards as well asformal communication from the RBI.

The reasons for the current state are understandable.However, banks should recognize that IFRS conversion cantake about 18–24 months and need to at least begin assessingthe impact that IFRS would have on their IT systems, capitaladequacy, taxes and product design, among others. A latestart may not only prove expensive by impacting the quality ofimplementation, it may also risk missing the deadline.



lusion




Notes



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