Reserve Bank of India Programme on International Financial Reporting Standards Impairment

1. Reserve Bank of IndiaProgramme on International Financial Reporting StandardsImpairment 20 May 2013 Ram Iyer

2. 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…

3. Agenda Approach Examples Implications Summary Planning Ahead

4. Loans and Receivables

5. No Provisions? Fixed Provisions? Hybrid Approach? Why a Different Approach? Age-based Provisions? Provisions based on Incurred Losses? How does a lender evaluate his loans? Provisions based on Expected Cash Flows? Regulatory Provisions? Provisions based on Expected Losses?

6. RBI (NPA) IAS 39 (Impairment) … 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 …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 Definitions

7. 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 (egincreased 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 39para 59

8. 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 39para 63

9. Common IFRS Models

10. Example: Homogeneous Loans

11. Example: Individually Impaired Loans

12. Case Study – Analyzing the Loan Book (1)

13. Case Study – Analyzing the Loan Book (2)

14. 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?

15. Case Study – Individual Provisioning (2)

16. 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?

17. Rs Millions How Results Can Move (1) (Growing) Portfolio of Good Loans Year

18. Rs Millions How Results Can Move (2) (Growing) Portfolio of Bad Loans Year

19. All the GAAPs

20. Disclosure Examples (1)

21. Disclosure Examples (2)

22. Held-to-Maturity Investments Carried at Amortized Cost

23. Approach: Similar to Loans and Receivables Examples – Investments in: Corporate Bonds PSU Bonds State Government Bonds

24. Available-for-Sale Financial Assets

25. Example: Accounting Policy …in the case of equity securitiesclassified 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…

26. 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

27. Examples

28. Further Reading Ifrs.org European Bank Annual Reports European Bank Websites Accounting Firms’ Websites Training Courses: ICAI, ICAEW, ACCA, AICPA, Accounting Firms

29. 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

30. Questions