RBI nudging lenders to enhance the quality of their disclosures

The Reserve Bank of India (RBI) is nudging regulated entities (REs) to enhance the quality of their disclosures so that they meet the needs of accounting standards and end-users, according to M Rajeshwar Rao, Deputy Governor.

“It is said that with great power comes great responsibility. Let me rephrase this to – “With greater flexibility in accounting and prudential norms comes greater responsibility in disclosures,” Rao said.

In his address at the Conference of Statutory Auditors and Chief Financial Officers of Commercial Banks and All India Financial Institutions (Regulated Entities/REs), he emphasised that disclosures are the cornerstone of transparency.

“Clear disclosures bridge the gap between what management knows and what external users can infer from financial statements. But the moot question is, how much disclosure is ‘good enough’ to ensure a clear understanding without overwhelming users with information overload.

“Striking a balance between comprehensive disclosure and conciseness is a tight rope walk. When disclosures are clearand comprehensive, they foster trust in the market,” Rao said.

Referring to the disclosures being made by NBFCs (non-banking finance companies) in the context of ECL (expected credit loss) framework, he noted that on perusal of the disclosures of the accounting policies of some NBFCs, RBI observed that much of the disclosures were largely a repetition of the text of respective accounting standards.

“We could not glean any specific insights such as discussion of the assumptions and methods applied in measuring ECL, shared credit risk characteristics to assess expected loss on a collective basis, qualitative criteria in determination of significant increase in credit risk (SICR), etc.

“To remedy this situation, we are nudging REs to enhance the quality of their disclosures,” Rao said.

Principle-based guidelines

The Deputy Governor said RBI’s assessment of implementation of principle-based guidelines in NBFCs shows that the flexibility offered by them, while valuable, has fallen short in some cases, where their application is concerned.

Highlighting certain issues and challenges which RBI encountered and which could have been evaluated by auditors more carefully, Rao said: “While the (principles-based) standards allow sale from assets under amortised cost category, an entity needs to assess how such sales are consistent with the objective of collecting contractual cash flows.

“In practice, we have observed that there have been significant sales from amortised cost category by way of securitisation and direct transfers.”

The Deputy Governor observed that it is not clear how such sales are consistent with business model whose objective is to hold assets in order to collect contractual cash flows.

Another example that Rao cited is how the impairment framework prescribed under Ind AS (Indian Accounting Standard) 109 is implemented.

“While the framework is forward looking and assessment of any significant increase in credit risk (SICR) for movement of assets from Stage 1 to Stage 2 is required to factor in more forward-looking criteria than just days-past-due (DPD), it has been observed that some NBFCs primarily rely on the 30 DPD criteria.

“DPD being a lagging indicator, is not always in sync with using the forward-looking approach of ECL (expected credit loss,” he said.

In case of Asset Reconstruction Companies (ARCs), RBI observed that no provision was created for management fees and expenses which remained unrecoverable for more than 180 days.

Such observations necessitated Reserve Bank to issue guidelines from a prudential perspective so that such unrealised management fees are deducted from regulatory capital while calculating capital adequacy ratios.

“The instances highlighted above bring forth our concern of regulated entities using the flexibility offered in the principle based framework in a way that is not free from bias. We are of the view that such issues require greater levels of skepticism from the auditors,” Rao said.

As independent assesors, he emphasised that auditors should critically evaluate and challenge management’s judgement and assumptions to ensure that the same are aligned with the underlying principles of the accounting standards and prudential norms.