New Delhi, 14 December 2020: 42 A latest EY Study of Non-Banking Financial Companies (NBFCs), including Housing Finance Companies (HFCs) has noted an increase in Expected Credit Loss (ECL) allowance by 33% and an overall increase in provision coverage rate by 26% as at 31 March 2020 compared to the year ended 31 March 2019. The EY Study, ‘Expected credit loss analysis for non-banking financial companies’ also shows that companies reported a COVID-19 impact comprising 19% of the ECL allowance as at 31 March 2020.
EY performed a review of the standalone financial statements for the year ended 31 March 2020, in comparison to year ended 31 March 2019 of 42 companies (28 NBFCs and 14 HFCs) to evaluate the change in ECL allowance and expense, change in provision coverage rates, the magnitude of the COVID-19 impact and other key parameters. The analysis highlighted that there has been an overall increase in gross loans of NBFCs by 7.63%, and HFCs by 2.44%. There was an increase in ECL allowance on stage 1 and stage 2 by 56% as against 25% increase in ECL allowance on stage 3 assets. The ECL expense has increased by 219% for the year ended 31 March 2020 as compared to year ended 31 March 2019. Also, the companies reported a COVID-19 impact of 32% of the ECL expense for the year ended 31 March 2020. The cost of risk ratio has increased by 202%.
Sandip Khetan, Partner and National Leader, Financial Accounting Advisory Services (FAAS) EY India said, “The increase in ECL allowance seems to be largely attributable to the impact of COVID-19 and other macro-economic factors. Provision coverage rate has also seen an increase primarily in consumer, MSME and auto, housing finance and micro-finance companies.”
To consider the impact of forward-looking information, NBFCs analyze 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. However, it is to be noted that while companies may have analyzed various macro-economic factors that could have an impact on the ECL, it may not be necessary that all the macro-economic factors would have a direct correlation with the ECL.
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.
Jigar Parikh, Partner, Financial Accounting Advisory Services (FAAS) EY India said, “As NBFCs gear up for financial results for the coming quarters as well as the year end, they will have to consider the impact of these challenges on the economy, additional insights on the economic impact of the pandemic and several regulatory developments as a part of stimulus packages provided by the government. ECL estimates may have to be revised in the wake of these developments. Given the inherent level of uncertainty and sensitivity of judgements and estimates, disclosures of the key assumptions used, and judgements made in estimating ECL are particularly important.”
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.
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