3 minute read 14 Dec 2020
Impact of expected credit loss in the financial statement reporting

What expected credit loss looks like for NBFCs in a world disrupted by COVID-19?

EY India
By EY India

Multidisciplinary professional services organization

3 minute read 14 Dec 2020
Related topics Financial accounting advisory services
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  • Expected credit loss analysis for non-banking financial companies

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Our analysis indicates that expected credit loss (ECL) has increased significantly in FY 2019-20 as compared to FY 2018-19, and on an average, 19% of ECL allowance pertains to the COVID-19 impact. 

COVID-19 has already had a significant impact on the global financial markets, including India, and it may have accounting and reporting implications for many entities. As Coronavirus continues to spread, and more information comes to light, the NBFC sector with 31 March 2020 year-end has considered the impact of expected credit loss in their financial statement reporting. Analysis by our financial accounting advisory services practice reveals that expected credit loss (ECL) has had one of the major impacts on standalone financial statements of NBFCs on transition to Ind AS, as the entities are required to consider the credit loss provision on a forward-looking basis.

The impairment requirements apply to debt instruments recorded at amortized cost or at fair value through other comprehensive income, trade receivables, lease receivables, contract assets, loan commitments and financial guarantee contracts that are not measured at fair value through profit or loss. ECL is recognized on loans based on the general approach wherein lifetime ECL is to be recognized if there is a significant increase in credit risk since origination. For assets which have not undergone a significant increase, a 12-month ECL shall be recognized.

It was observed that 42 NBFCs (including HFCs) noted a COVID-19 impact comprising 19% of the ECL allowance for the year ended 31 March 2020. Also, the provision coverage rates have increased by 26% for the year ended 31 March 2020 as compared to the year ended 31 March 2019.

To consider the impact of forward-looking information, NBFCs analyse co-relation of a wide range of factors with their default patterns and shortlist the factors that are relevant to their respective businesses. ECL estimates are then adjusted to consider the impact of these short-listed factors. GDP and unemployment rate were the most common macro-economic factors that were considered by the companies while evaluating the impact on their ECL computation. Further, many companies also considered inflation and interest rates.

The assessment of the impact of the COVID-19 outbreak on ECL involved significant judgement specifically because it is not directly comparable with any recent similar events. Different companies have applied different approaches to determine the impact of forward-looking factors while estimating ECL. Majority of them have applied a management overlay approach to embed the expected impact that is not fully captured by their ECL models.

While NBFCs are struggling to predict and manage credit risk amidst the pandemic, it has become imperative for them to have a strong risk management framework. Some of the factors that NBFCs may consider in risk management are assessment of creditworthiness of the borrower, mitigation of credit risk by reviewing value of collaterals on a regular basis and regular back-testing.

The increase in the provision coverage rate has been witnessed primarily in consumer, MSME, auto finance and micro-finance companies.
Jigar Parikh
EY India Financial Accounting Advisory Services Partner

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Summary

As NBFCs gear up for financial results for the coming quarters as well as the year end, they will have to consider the factors such as stage 2 and stage3 transfers post moratorium period, payment behaviour of borrowers post completion of moratorium, government support measures, and changes in macro-economic scenarios and assumptions in estimation of ECL.

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EY India
By EY India

Multidisciplinary professional services organization

Related topics Financial accounting advisory services
Upvote