How expected credit loss has impacted NBFCs one-year into the pandemic

Ind AS has been applicable to large NBFCs since FY 2018-19. ECL has one of the most significant impact on the financial statements of an NBFC. While the models and methodologies for computing ECL are largely set, the computation was thrown slightly off-balance with the onset of the COVID-19 pandemic. While FY20 was the first year of the pandemic where companies estimated its impact through various techniques and data points available, FY21 caused challenges due to its second wave.

In December 2020, we had published an analysis on “Expected credit loss analysis for non-banking financial companies”. It mainly focused on the impact of ECL for NBFCs for the year ended 31 March 2020 and how the unprecedented situation of the COVID-19 pandemic impacted ECL estimates. The current publication aims to analyze the impact of ECL for NBFCs for the year ended 31 March 2021 and understand how companies have performed during the pandemic compared to FY 2019-20.

In FY20, there was a sharp increase in ECL allowances and expenses when compared to FY19. In FY21 though there is an increase in ECL allowance and ECL expense as compared to FY20, the rate of increase has dropped. This could be because companies had already largely factored in the potential impact of COVID-19 in FY20. The overall reduction in the rate of increase appears to be primarily on account of reduction in the rate of increase in ECL allowance on stage 1 and stage 2 loans. It appears that significant management overlays on account of COVID-19 were already considered in FY20 and consequently there is a lower rate of increase in the current year.

While businesses across various parts of the country are resuming their operations gradually with some visibility of the pandemic situation, they are still facing challenges due to the change in the macro-economic environment. Although companies have developed models and methodologies to determine ECL provisions, we estimate that even after two annual reporting cycles the situation is evolving.

The measures and relief provided by the Government have played a role in determining ECL estimates for companies. RBI, with the intent to facilitate revival of the sectors activities and mitigate the impact on ultimate borrowers, had proposed restructuring frameworks to allow restructuring of loan accounts. They stress on the eligibility criteria as per their circular dated 06 August 2020, 05 May 2021 and 04 June 2021 which account for COVID-19. The resolution framework primarily focused on Micro, small and medium enterprises (MSME), individuals and small businesses and personal loans.

The entities going forward may need to undertake a few measures to strengthen their risk management framework so that the difference between its ECL estimate and the actual credit loss experience reduces.