While institutional investors are going gung-ho on financial stocks, not all’s well in the sector. Banks, especially, are grappling with high NPA and the needed provisioning, which is impacting their bottom-line.

And if the situation does not improve, it looks like their bottom-line could be affected furthermore, beginning in the next fiscal year, i.e. from April 1, 2018,

Why?

The Indian Accounting Standard (Ind AS) 109 comes into force from the next financial year to battle the menace of high NPAs vide additional provisioning that will impact the profitability of banks.

What is noteworthy is Ind AS 109 will work in congruence with the International Financial Reporting Standard (IFRS).

In an interview with the Press Trust of India (PTI), the President of The Institute of Chartered Accountants of India (ICAI), Mr Nilesh Shivji Vikamsey said, “It (Ind AS 109) is an accounting policy that has to be followed and that will have huge ramifications on the numbers. The provisioning will be more and P&L (Profit & Loss) will be impacted.”

He also expects that the implementation of this new accounting standard will affect the capital adequacy provisioning. He opinioned that banks may find it difficult to implement Ind AS 109 for numbers in the years prior.

However, the new accounting standard has been designed to withstand shocks like the global financial system passed through in 2008. The fundamental difference between the provisioning norms under the current accounting policies and those recommended under Ind AS 109 is that the former are based on the ‘incurred losses’, while the latter will focus on the ‘expected losses.’

This makes it very crucial for banks and Non-Banking Financial Companies (NBFCs) to have sound risk management processes in place as the expected losses will be different for different lenders, based on their risk assessment and credit evaluation.

Investors must remember some key points…

• Non-Performing Assets (NPAs) of Indian banks are worth nearly Rs 7 lakh crore. However, the deterioration in the asset quality that we are witnessing now pertains to poor lending practices of yesteryears. Learning from their past mistakes, many banks seem to have focused on tighter risk assessment now. Therefore, it might be slightly inappropriate to conclude that they will suffer similar problems even in future.
   
• Again, it would be wrong to infer that all banks will be equally affected by the implementation of the new accounting standards. NPA levels, existing provisioning practices, and quality of credit growth over the past few years will be crucial factors to watch out for. Banks and NBFCs that are maintaining higher provisions and are rightly following conservative practice for stress identification and asset classification.
   
• Taking a call on an individual bank will be difficult for individuals and non-savvy investors. And, investing in a banking sector fund would be equally risky.
   
• Banks are likely to benefit from the cyclical recovery of Indian economy; but which ones are perfectly positioned to ride the cyclical upswing is a tough call.
   

In case you are investing in equities, leave the work of identifying the right ones to professional fund managers. But avoid taking exposure to banking sector fund as it can be highly risky. Instead, invest in diversified equity funds, – the ones following an opportunities style that benefits from attractive investment options.

In case you are unsure which equity mutual fund to invest in, you may take advantage of PersonalFN’s unbiased mutual fund research services: FundSelect. You’ll discover the 6 Ultimate Secrets to Beating the Market By A Whopping 70%!

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