Provisioning under Indian Accounting Standards’ (Ind-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 effective 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 and value of the collateral is getting affected.” ECL is based on two key parameters – the probability of default and loss given default (actual loss if the default occurs). The latter is also a function of the value of the collateral.
Sai Venkateshwaran, partner and head, CFO Advisory at KPMG India echoes 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 higher versus GAAP as the ECL model would require lifetime losses to be recorded where there is a significant increase in credit risk.
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, etc, which NBFCs need to factor in while ascertaining future default probability. “Though the regulator has given some respite through moratorium, it is unlikely to completely eliminate lenders’ credit risk,” says Attra.
A likely deterioration in 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, “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 upon 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, the resale value of collateral, etc, are considered while deciding additional provisioning due to Covid-19, say V Ravi, executive director, and CFO at Mahindra and Mahindra Financial Services. The private lender will also be making additional 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 Covid-19.
Although markets are hoping that a stimulus package by government or regulator could provide some relief on this front, the jury is out.