Reserve Bank of India
Programme on International Financial Reporting Standards
Impairment
20 May 2013
Ram Iyer
Annual Report - Bank in India
Annual Report – Bank in Europe
The Group first assesses whether
objective evidence of impairment exists
individually for loans that are
individually significant…amount of
loss is determined as difference between
carrying amount of loan…and present
value of expected future cash flows
discounted at loan’s original effective
interest rate…
…incurred losses on portfolio of
smaller balance homogeneous
loans…to individuals and small business
customers…loans are grouped according
to similar credit risk characteristics and
allowance for each group is determined
using statistical models based on
historical experience…
2
Agenda
•
•
•
•
•
Approach
Examples
Implications
Summary
Planning Ahead
3
Loans and
Receivables
Why a Different Approach?
How does a lender
evaluate his loans?
5
Definitions
RBI (NPA)
… ceases to generate income
for the bank
…interest and/ or instalment
of principal remain overdue
for a period of more than 90
days
…remains ‘out of order’
…Substandard Assets…NPA for
</=12 Months
…Doubtful..Substandard for
12 Months
…Loss…Uncollectible
IAS 39 (Impairment)
…objective evidence of
impairment as a result of one
or more events
…has an impact on the
estimated future
cash flows of the financial
asset or group of financial
assets that can be reliably
estimated
…Losses expected as a result
of future events, no matter
how likely,
are not recognised
6
Impairment Indicators
• significant financial difficulty of obligor
• breach of contract, such as a default or delinquency
• the lender…granting to borrower a concession
• probable that the borrower will enter bankruptcy or other
financial reorganisation
• observable data indicating that there is a measurable
decrease in the estimated future cash flows
(i) adverse changes in the payment status of borrowers in the
group (eg increased number of credit card borrowers who
have reached their credit limit and are paying the minimum
monthly amount); or
(ii) national or local economic conditions that correlate with
defaults (eg decrease in property prices for mortgages in the
relevant area, decrease in oil prices for loan assets to oil
producer, or adverse changes in industry conditions)
IAS 39 para 59
7
Measuring Impairment
If there is objective evidence that an
impairment loss on loans and receivables or
held-to-maturity investments carried at
amortised cost has been incurred, the
amount of the loss is measured as the
• difference between the asset’s carrying
amount and the present value of estimated
future cash flows (excluding future credit
losses that have not been incurred)
• discounted at the financial asset’s original
effective interest rate (ie the effective
interest rate computed at initial recognition)
IAS 39 para 63
8
Common IFRS Models
General Approach
Good Loans
Impaired Loans
Pools of
Homogeneous Loans
Individually
Evaluated Loans
Evaluated and provisioned on a
In d i v i d u a l l y
pool basis
assessed and
p r o v i d e d fo r , g e n e r a l l y
using a discounted cash
fl o w a p p r o a c h
9
Example: Homogeneous Loans
10
Example: Individually Impaired Loans
Making provision for an impaired loan
Rupees Million
Expected Gross Cash Flows (at each year end)
Discount Rate (contractual interest rate)
Present Value
Balance Sheet Carrying Value
Impairment Provision
Year 1
90
Year 2
90
Year 3
90
Total
270
10%
224 (A)
250 (B)
26 (B-A)
11
Case Study – Analyzing the Loan Book (1)
12
Case Study – Analyzing the Loan Book (2)
13
Case Study – Individual Provisioning (1)
• Project Finance Term Loan
• Fully secured (recovery in default may not be easy)
• Outstanding Balance: 100 million
• Remaining Tenor: 3 Years
• Project affected by delays, latest loan installment is missed
• Expected Cash Flows to Lender: 35 million each year
• Contractual Interest Rate: 10%
• Market Interest Rate: 9%
• Is the loan impaired?
• How are the cash flows calculated?
• Discount at what rate of interest?
• What might be the Indian GAAP provision?
• What might be the IFRS provision?
14
Case Study – Individual Provisioning (2)
Making provision for an impaired loan
Rupees Million
Expected Gross Cash Flows (at each year end)
Discount Rate (contractual interest rate)
Present Value
Balance Sheet Carrying Value
Impairment Provision (IFRS)
Impairment Provision (Indian GAAP)…….(1)
Impairment Provision (Indian GAAP)…….(2)
Year 1
35
Year 2
35
Year 3
35
Total
105
10%
87 (A)
100 (B)
13 (B-A)
0.4 0.40%
15
15%
15
Implications
• Perhaps recognize impairment earlier than usual
• Consider expected cash flows
• Discount rate is crucial
• Significant use of judgment
• Important to document the rationale
• Future information does not diminish quality of numbers
• Gather data, analyze
• Above all: Don’t be afraid to use judgment
Potential
Pitfalls?
16
How Results Can Move (1)
(Growing) Portfolio of Good Loans
Rs Millions
120
100
80
Indian GAAP (0.30%)
60
IFRS (0.20%)
40
20
Year
0
1
2
3
4
5
6
17
How Results Can Move (2)
(Growing) Portfolio of Bad Loans
Rs Millions
25000
20000
15000
Indian GAAP (60%)
IFRS (45%)
10000
5000
Year
0
1
2
3
4
5
6
18
All the GAAPs
Indian GAAP
Ind AS
IAS 39
IFRS 9
RBI Prudential
Norms
Probably as per
IAS 39, coupled
with RBI
Prudential
Norms??
Incurred Loss
Model
Expected Loss
Model
Contrast with
IAS 39
definition!
19
Disclosure Examples (1)
20
Disclosure Examples (2)
21
Held-to-Maturity
Investments Carried
at Amortized Cost
Approach: Similar to Loans and Receivables
23
Available-for-Sale
Financial Assets
Example: Accounting Policy
…in the case of equity securities
classified as AFS, objective evidence of
impairment would include a significant
or prolonged decline in fair value of the
investment below cost. It could also
include specific conditions in an industry
or geographical area or specific
information regarding the financial
condition of the company, such as a
downgrade in credit rating. In the case of
debt securities classified as AFS,
impairment is assessed based on the
same criteria as for loans…
25
Key Points
• Fair value changes recognized in OCI (Other Comprehensive Income)
• If asset impaired, then loss recycled to P&L
• Loss = Difference Between Acquisition Cost (Net of any Principal
Repayment and Amortization) and Current Fair Value, Less any
Impairment Loss Previously Recognized in P&L
• Subsequent Recoveries in Fair Values
• Equity Instruments: Adjusted in OCI, not P&L!
• Debt instruments: Adjusted in P&L
26
Examples
Cost
FV
YR 1
YR 2
YR 3
YR 4
Equity
100
110
95
75
105
Debt Likely Accounting
100
110
95
75
105
10 FV Increase Through OCI
15 FV Decrease Through OCI. Total Decline Below Cost = 5
25 Impairment Loss Through P&L (of which 5 Recycled from OCI)
Equity: 30 Credit Through OCI, Not P&L!
Debt: 25 Credit Through P&L, 5 Credit Through OCI
27
Further Reading
• Ifrs.org
• European Bank Annual Reports
• European Bank Websites
• Accounting Firms’ Websites
• Training Courses: ICAI, ICAEW, ACCA, AICPA,
Accounting Firms
28
Planning Ahead – Phase I
• Form a small team
• Analyze the loan book
• Determine the provisioning approach
• Discuss with other banks
• Design templates
• Do high-level analysis
• Document the approach
• Document the gaps
29
Questions
30