Swaraat / C A N S Padmanabhan
The sudden disclosure by Indusind bank that their profit will take a hit of about ₹ 1577 crores in quarter four of 2024-2025 gave a major jolt in banking circles and Stock Markets.
*Derivatives*
The future Foreign exchange payments in the form of Loans or imports or future foreign exchange receipts in the form of deposits are vulnerable to international exchange rate fluctuations.To protect the extreme volatility and hit due to exchange rate fluctuations banks try to match the payments and receipts from their internal books. These may not exactly match vis-a-vis currency amount or tenors.
It appears Indusind Bank has tried to hedge these through internal trades and has also entered into deal with Interest rates swaps. These deals would incur cost in the form of premium. Further, Indusind Bank has also entered into Exchange rate as well as fixed and floating rate swaps in global markets.
*Accounting Treatment*
The yen borrowing or $ Dollar international borrowings or such other currencies would be relatively cheap compared to domestic interest rates. It may be even less than Libor rates. However, the repayment would be in that currency and would involve exchange rate fluctuations in future. So the cost of funds would be low interest rates but in foreign currency plus the exchange rate at the extant date of outflow.To nullify or at least envisage the uncertain future exchange rates banks generally enter into exchange rate swaps.
No principal amount is shelled out. On a notional principal amount ( which ideally should be corresponding to bank internal future outflow/inflows) the exchange rate swap is entered freezing the exchange rates at a particular number. For instance if $ Dollar – ₹ rupee rate is 82, the future envisaged rate may be frozen at 85 or 88. This depends on the tenor of the instrument, the currency and forex market perception of the future period.
These deals are not free of cost and a premium is collected either upfront or a fixed amount, either in Indian rupees or foreign currency periodically.These contract or the swaps is valued regularly and the notional loss or gain is marked to market and expensed off or taken to income of the bank as the case maybe. Indusind Bank, it seems has done this leg correctly.
The need for such valuation arises because while the swaps are freezing the rate at a particular amount, in actual the forex rates may vary. The more it varies, more the fluctuation on the value of the deal. Every quarter the deal is valued in coherence with actual market movements and factors like future instalments, tenor currency and other multiple variables are factored in this complicated valuation.
The internal trades which are hedged are also valued accordingly. But as per Indusind Bank Management these have been taken to Balance sheet in the past six or seven years and accumulated.
*The Mismatch*
Whilst the international swaps have been valued regularly and marked to market in the profit and loss account, the net loss on hedged internal trades due to such mark-to-market have been carried to balance sheet. Thus, one leg of the transaction has gone into revenue account whereas the other corresponding leg has gone into Balance Sheet. Ideally these should have been amortised as per the deal period, amounts etc.
The mismatch has been accentuated by preclosure of deals .The periodic valuation of deals intends to minimise the pre-evaluated forex based on swaps and actuals position on a regular basis. This insulates the sudden or one time hit on the revenue account.It is also understood that the migration to new forex platform might have been one of the reasons for such a lapse.
*The Unanswered Questions*
The Bank has come out with a statement that this was only an accounting mistake.If so why was the mistake not detected for several years? Did it escape RBI inspection also besides other audits? Was it an accounting violation to boost the bottom line? It is reported that this anomaly was discovered after an RBI circular of reviewing internal trades.The magnitude is reported to be Rs 1577 crores 2.35 percent of networth.
RBI has come out with a statement that Bank’s Capital adequace and other basic parameters are strong and there is no need for panic.However, is this the only anomaly or more skeletons are in the cupboard? This question arises as auditors have sought for forensic audit.Till other banks come out with a assertive statement that they don’t carry any unamortised amounts in their books the question of potential loss of other banks cannot be ruled out.
The Institute of Chartered Accountants of India may initiate a probe in this regard.Till these and related questions remain unanswered, nobody can be certain whether these derivatives have been accounted completely.