@IVEY | Publishing —_—_—___-— YX m<\rKKY\¥wqYr————————_________ w20547 BANK OF INDIA: FINANCIAL REPORTING POLICIES" Veh) Ratt and Pradip Banerjee wrote this case solely to provido materia for cles elecussion. Tha authors do not intend to ie eer effective or ineffective handing of a managorial sition. The author ther fet orice aig ng iors may havo disguised contain names and othor ‘ puteton may no be ranenited,polcope, ded er thei raprotucd in ny le ob ony mao wou the ete nye hace, Repodton of Ue rane! emt covtd wer eerclon ay onset et rs on eer cp or oqie! parmizson fo rpoaice nial corto iy Publi, Noy Buse toa, Wasa OE agit, Caras, HOG ONT () 8106012908) casos x; womoyeatercom. goa plan Cae qely sul oy orate [email protected], Cconright © 2020 Wey Business Schoo! Foundation in Jenvary 2015, Harish Pandey bought 1,000 shares of Bank of India (BOI) stock at %305* per share. Pandey’s investment adviser had recommended purchasing BOI shares, stating that the banking sector was ‘expecied to perform better over the medium to long term. However, on October 11, 2019, after holding the BO! shares for nearly five years, Pandey was surprised to see that the stock price had instead dropped by almost 80 per cent, hovering at around 260 per share, Pandey was disappointed in his investment’s performance to date. However, BOI stock’s current low price seemed a bargain, so he was contemplating buying more shares for overall cost averaging of his investment. BOL was still holding its position as the fifth-largest public seetor bank in India’ Before making any investment decisions, Pandey carefully analyzed the bank's annual reports for the previous five years. Having reviewed BOI’s financial statements, he was puzzled by the auditor's report for fiscal year (FY) 2015-16. The auditor had highlighted a change in BOI's accounting policy, under the heading “Emphasis of Matter,” and explained the accounting change: Note No.18.4 to the financial statements relating to change in accounting policy for provisioning in respect of NPAs {non-performing assets] classified as Doubtful (secured portion) —one year to three years resulting in decrease in provision for NPAs for the year by 28.35 billion with consequential decrease in Net loss for the year (net of tax) by 218.54 billion.* Pandey wondered about the meaning and importance of the auditor's use of the unusual heading “Emphasis of Matter.” He also noted that the auditor provided no further statement or concern on this matter after FY 2015-16. After his review of BOI's financial statements, Pandey was unsure whether he should sell his shares, buy more shares to achieve overall cost averaging, or hold the number of shares he currently owned. eee Tras caso fas been won on bas of pubtahad omy wate sed sources only. Consequently, the iterpretalon and perspectives rsdn cae cea ae of ao canceemeree me FER eps agen vs aaneny amon oes cee ei Boe yas Tan 0 Barks in In by Sle and Ma i «Soe rina. tet opal Mas tie og 2 208 ened on or oe ny ialtnesatopBaare- ram bonketinda.co.ivUserFiesIFI6/EO! AbidgedaR201516 WER bl 2 2018,BANKING IN INDIA sl system. jor role of banks was to channe] ing. system. The major role of ban! to chan and had a cous barking 7 eee ae 2 aera sector were worth approximately 21.17 trillion in Marc segments, Total deposits in the Indian ban ee 7 : Mach 7 fe per cent of India’s gt i 1 bank: 2018, which was equivalent to 45 per cent of Ind re Sdn banks, 56 regional rural banks, and onsisted of 27 public sector banks, 22 private sectors banks, 44 foreigh mA i Eee cant sak of March 2018, the total eredit extended by commercial banks was 887,460 billion (approximately USS1,345 billion).” India was a bank-based economy’ resources from savers to investors through sctor banks in India were statute based. They were constituted by an act of | parliament and fell under the Satie Reahte of 1949.8 The first public sector bank was the Sate Bank of ni, which was nationalized in 1955, All other private banks were nationalized in two phases, first in 1969 and then in 1980. The Government of India started allowing private banks and foreign banks to operate in India after the country’s economic liberalization in late 1991. According to the Banking Regulation Act of 1949, the Government of India was required to hold at least 51 per cent of equity ownership (shareholding) in public sector banks. However, private sector and foreign banks did not have this restriction. India’s central bank, the Reserve Bank of India (RBI), governed the entire banking system. Most Indian banks followed Basel Il accord norms, and many already met the capital requirements of the Basel III accord, well before the requirement to do so as of March 31, 2019.9 All public More than 65 per cent of the Indian population lived in rural areas. While celebrating the 68th Independence Day on August 15, 2014, the prime minister launched the Pradhan Mantri Jan Dhan Yojana initiative, which zimed to provide every Indian household with access to financial services, such as remittance, credit, insurance, and a pension, through bank accounts. The initiative led to the opening of 318 million new bank ecounts and deposits of £792 billion into these accounts by June 2018.!° After India’s economic liberalization and global economic integration, competition increased immensely \within the banking sector. From 2016 onward, the asset quality of Indian banks had drastically deteriorated due to sluggish industrial growth and a decline in corporate profitability." Sectors such as electric and gas power, real estate, iron and steel, textiles, aviation, telecommunication, infrastructure, construction, and automobile manufacturing struggled from various issues and challenges. The hardships led to a constant rise in the NPAs of Indian commercial banks. The net NPA provisioning had risen from %391 billion in 2010 to 24.33 willion in 2017. Similarly, the net NPA as a percentage of gross advance and net NPA as a percentage of total assets had gone up by nearly fivefold during this period (see Exhibit 1). These trends ‘were even worse for public sector banks at an aggregate level (gee Exhibit 2), © rete Tut onda, Ha of Bank Depots Conibutd by Indu: Rl als: ROI Daa” Tnes of nd, Jy 20, 2018, acessed November 1? 20%, hipefeconomiies indslines sues individuals-rbi-data/articleshow/65203915.cms. *rybarkingfinancelhal-of-bank-deposis-conbbuted-by- Pinon Barking Indi” Anahale® ela Brand Eauty Founda, were ibef.org/industry/banking-presentation. - wation, March 2020, accessed May 11, 2020, 2 ening. Sector in Ind? Indan Grand Eauly Foundation, Se wwrw bef orglindustry/banking-india.aspx. * September 2019, accessed April 21, 2019, ce epopuaton “al tains Siles Times, March 45, iplstatatestnesconldemograpis/ppuiatin otra. pb Deparnt of Foe pr Yt Jan ees Yojana,” Government of Incia, accessed May 11, 2020, hiipilipmidy gov inlabeut See raanAN Mant Jan Dh “SEIS Bucoss Une Burne, : dune 20,2017 sonst tay bbanks-continue-to-doteriorate-rovaricle22637076.0ce1—— vozubuie EMPHASIS OF MATTER: ACCOUNTING POLICIES Generally, when managers prepared reports for the differents potential investors, lenders, creditors, And regulatory authorities, the ‘managers had to choose an appropriate accounting convention. That convention became the hasis for the necessary measurements to prepare the omapany’s financial repo was chosen, the consistenc r ¢ follow. « 5 y principle demanded that similar practices be followed in subsequent periods, unless a critical need meee to change that chosen method. Ifthe company’s accounting method changed, the auditors were required to express and highlight their opinion in the company’s annual reports, which were Prepared for the benefit of all stakeholders. lakcholders of a company, such as current and The principal source of revenue fora bank in India was lending deposit for short, medium, and long terms, which comprised the major assets of the bank. Lending assets that were earning interest incone were classified & performing assets. Ifany of these assets ceased generating income for the bank, they became classified as non-performing assets, or NPAs. India's 2002 Secwitization and Reconstruction of Financial Assets and Enforcement of Security Interest ci characterized NPAs as “a benefit or record of a borrower, which had been grouped by a bank or money lated establishment as substandard, far-fetched or misfortune resources as per the heading and rules ‘identifying with resource arrangement issued by the RBI." A bank's loan assets were classified into four categories: standard, substandard, doubtful, and loss. Standard assets were not considered NPAs because they generated regular interest and principal repayment, so they generally carried only normal business risk. A substandard asset was an asset that had remained NPA for 12 months or less. Once an asset had been substandard for more than a year, it became a doubtful asset; collection or liquidation of the asset was unlikely. An asset that was considered uncollectible but had not ‘yet been written off became a loss asset; it would not be considered a bankable asset, although the bank ‘ay be able to recover some residual value."? Afier classification of the entire loan portfolio, the bank would have to create mandatory provisions for these different types of assets. The level of provisions depended on the types of assets and varied from 0.25 er cent to 100 per cent. That decision rested with the RBI (see Exhibit 3). The aggregate amount of the Provision was then deducted from the income statement and subsequent reduction was made from the loan assets in the balance sheet. : a? kK ling to RBI estimates, the gross NPA Each bank in India felt the pressure of managing its loan book. According to Le ratio of Indian banks was expected to inerease to 9.9 percent by the second quarter of 2020-21." Therefore, resolving these stressed assets was a significant challenge for the entire banking sector. Soe nfrcoment of Sear Interest Act, 2002, et No. 84 of 2002, :Secintzatin and Reconstruction of Financial Assets and Ef 2 . rset an eco fe ae gor svete a ° Reccre gct india, accessed My den Nas on lacome Resognin, Asse Classifatin and Provisioning Petaieg ia” Ravnces SV2008 10799, of, 100% A. een May 12th 1 prc a in Scrints/BS._ ViewMasCiculardeels Are 5 Ses ad Loans Rising in 2020," Eoonomic Times, December a, 2010, a ea et Pape: econo naainescommakesistocksnews/baks sot ouofhe Niperiatmanaesto oy. sep 2020 2 3 9 90,0000 bad Leas tom amin Quart inda, Fabry 8, 2018, ‘uted mutate Mpeg cons ingae sion Geos Sk cereape ren n eth vrocnajen nn rrr Wenonte Cvarct itte Res Maeno and (MA) om Ot 2024 tw A208 Sutra or use nl in Prot Rajesh is