Since its inception in 1980s) BIS has issued several guidance notes for banks and
bank supervisors. These notes have sought to improve the integrity of the global banking system and propagate best practices in banking across the world. For issues related to accounting, BIS has relied on the International Accounting Standards (IAS) issued by the International Accounting Standards Committee (IASC). Banks are supposed to follow these accounting standards as part of best practices. For the structural benchmarking study of the Indian banking sector, ICRA has used primarily the guidance notes issued by BIS and the relevant IAS as the benchmarks of best practices. ICRA has also referred to standards as mentioned under, US and UK. GAAP (Generally Accepted Accounting Practices) where they provide a good understanding of international best practices.
• Capital Adequacy Norms for Banks
BIS introduced capital adequacy norms for banks for the first time in 1988. To improve on the existing norms, BIS issued a Consultative Document in January 2001, proposing changes to the existing framework. The objective of this document is to develop a consensus on the Basel II Accord (as it is popularly known), which is expected to be implemented in 2007. Based on feedback received from various quarters, BIS issued a new Consultative Document in April 2003. In this document, BIS has proposed the following key changes over the existing norms:
According to the original 1988 Accord, all credit risks have a 100% per cent weighting. Under the new method, grades of weightings in the 20-150% range will be assigned.
• Introduction of charges for operational risks:
Under the proposed Basel II Accord, banks have to allocate capital for operational risks. BIS has suggested three methods for estimating operational risk capitals:
1. Basic Approach, 2. Standardised Approach, and
3. Advanced Measurement Approach.
• Capital requirement for mortgages reduced:
The risk weights on residential mortgages will be reduced to 35% from 50%. During the 1990s, the RBI adopted the strategy of attaining a Capital Adequacy Ratio (CAR) of 8% in a phased manner. Subsequently, in line with the recommendations of the Committee on Banking Sector Reforms, the minimum CAR was further raised to 9%, effective 31st March 2000.
As a step towards implementing the Basel II guidelines, the RBI in its circular of 14th May, 2003 has proposed new methods for estimating regulatory risk capital. To estimate the impact of the proposed changes on the capital adequacy position of Indian banks, the RBI has asked select banks to estimate their riskweighted assets on the basis of the new method. As per this, the RBI has asked for the estimation of capital requirement on the basis of the external credit rating of borrowers. For nonrated borrowers, the RBI has asked the select banks to use the existing 100% risk weights.
The RBI has also asked the banks to calculate operational risk capital separately following the Basel approach. Based on the result of the exercise, the RBI will issue new guidelines on estimating economic capital.
Additionally, the RBI has asked banks to introduce internal risk scoring models. It is expected that once the Basel II Accord is signed, the RBI will allow banks to move to the IRB approach.
The Capital Adequacy norms in India are in line with the best practices as suggested by BIS. Once the Basel II Accord is implemented, the method of estimation of risk capital will undergo a significant change. RBI has already taken appropriate steps to prepare the Indian banking industry for such changes.
• Recognition of Financial Assets & Liabilities
IAS 39 requires that all financial assets and all financial liabilities be recognised on the balance sheet. This includes all derivatives. Historically, in many parts of the world, derivatives have not been recognised as liabilities or assets on balance sheets. The argument for this practice has been that at the time the derivative contract was entered into, no cash or other asset was paid. The zero cost justified non-recognition, notwithstanding the fact that as time pauses and the value of the underlying variable (rate, price, or index) changes, the derivative has a positive (asset) or negative (liability) value.
In India, derivatives are still off-balance sheet items and considered part of contingent liabilities. So in Indian treatment of derivatives is different from International Accounting Standards.
• Valuation of Financial Assets
IAS 39 has classified financial assets under four categories. The following table summarises the classification and measurement scheme for financial assets under IAS 39, Under US GAAP, marketable equity securities and debt securities are classified as under:
• trading,
• Available for sale, or • held to maturity.
• Recognition of Non-Performing Assets (NPAs)/Impaired Assets
Under IAS 39, impairment recognition is left to management discretion (its perception of the likelihood of recovery). Impairment calculation compares the carrying amount of the financial asset with the present value of the currently estimated amounts and timings of payments. If the present value is lower than. The carrying amount, the loan is classified as NPL.
Under US GAAP, loans assume non-accrual statuses if any of the following conditions are fulfilled:
Full repayment of principal or interest is in doubt (in management's judgment), or if scheduled principal or interest payment is past due 90 days or more, and if the collateral is insufficient to cover the principal and interest.
In India, NPAs are classified under three categories-Sub-standard, Doubtful and Loss on the basis of the number of months the amount is overdue for. India proposed to
move from 180 days to a 90-day past due classification rule for NPA recognition effective March 2004.
The financial instrument's original effective interest rate is the rate to be used for discounting. Any impairment loss is charged to profit and loss account for the period. Impairment or "uncollectability" must be evaluated individually for material financial assets. A portfolio approach may be used for items that are individually small [IAS 39.109]. Therefore, under IAS, provisioning is based on management discretion. Provision in excess of expected loan losses may be booked directly to shareholders' equity. As with IAS, under the UK, And US GAAP also, provisioning is based on management discretion. Under US GAAP, when the Net Present Value of a loan is less than the carrying value, the difference is booked as provision.
In India; provisioning norms are more explicit than they are under the IAS. RBI has specified norms for various classes of NPL as follows:
Standard Assets: 10%
Doubtful Assets: 100% of unsecured portion, 20-50% on secured portion
Loss Assets: 100%
Interest Accrual on M on-performing Loans / impaired Assets
Under both IAS and US GAAP, there is no specific prescription for interest accrual on NPAs. Under UK. GAAP, interest is suspended upon classification as NPL. However, suspension may be deferred up to 12 months if sufficient collateral exists.
According to Sound Practices for Loan Accounting and Disclosure (1999) number 11, the BIS Committee on Banking Supervision recommends that when a loan is identified as impaired, a bank should cease accruing interest in accordance with the terms of the contract. Interest on impaired loans should not contribute to net income if doubts exist over the collectability of loan interest or principal.
In India, accrual of interest is suspended upon classification of a loan as non performing.
Under IAS, UK and US GAAP, there is no specific prescription for general provisioning towards performing loans. However, Indian banks have a provisioning require; f tent of 0.2 5% on all standard assets.
• Conclusion
The RBI norms for classification of assets, and provisioning against, bad/doubtful debts are more detailed and precise vis-a-vis international rules. While the international norms often leave bad debt provision levels to "management discretion", Indian standards are precise and clearly state exactly when and by how much reported earnings must be charged off for bad debts.
In India, detailed accounting standards for derivatives are yet to be introduced. As of now, derivatives continue to be considered as off-balance sheet liabilities.