Friday, May 26, 2017

Financial Statement Analysis Notes: Financial Reporting By Banks, Insurance Companies and NBFCs

Unit – 4: Financial Reporting By Banks, Insurance Companies and NBFCs

A banking company is defined as a company which transacts the business of banking in India. Section 5 (b) of The Banking Regulation Act, 1949 defines the term banking as “accepting for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdraw able by cheque, draft, order or otherwise.
Section – 7 of this Act makes it essential for every company carrying on the business of banking in India to use as part of its name at least one of the words – bank, banker, banking or banking company. Section 49A of the Act prohibits any institution other than banking companies to accept deposit money from public withdraw able by cheque. The essence of banking business is the function of accepting deposits from public with the facility of withdrawal of money by cheque. In other words, the combination of the functions of acceptance of public deposits and withdrawal of the money by cheque by any institution cannot be performed without the approval of Reserve Bank.

Features of Banking: The following are the basic characteristics to capture the essential features of Banking:
a)      Dealing in Money: The banks accept deposits from the public and advance the same as loans to the needy people. The deposits may be of different types – current, fixed, savings, etc. accounts. The deposits are accepted on various terms and conditions.
b)      Deposits must be withdraw able: The deposits (other than fixed deposits) made by the public can be withdraw able by cheques, draft or otherwise, i.e., the bank issue and pay cheques. The deposits are usually withdraw able on demand. 
c)       Dealing with credit: The banks are the institutions that can create credit i.e., creation of additional money for lending. Thus, “creation of credit” is the unique feature of banking.

d)      Commercial in nature: Since all the banking functions are carried on with the aim of making profit, it is regarded as a commercial institution.
e)      Nature of agent: Besides the basic function of accepting deposits and lending money as loans, bank possesses the character of an agent because of its various agency services.
There are various types of users of the financial statements of banks who need information about the financial position and performance of the banks. The financial statements are required to provide the information about the financial position and performance of the bank in making economic decisions by the users. The important information sought by these users are, about bank’s Liquidity and solvency and the risks related to the assets and liabilities recognized on its balance sheet and to its off balance sheet items. This useful information can be provided by way of ‘Notes’ to the financial statements, hence notes become an integral part of the financial statements of banks. The users can make use of these notes and supplementary information to arrive at a meaningful decision. Some of the specific disclosure requirements in Bank’s financial statement are given below:
a) Presentation: Summary of Significant Accounting Policies’ and ‘Notes to Accounts’ may be shown under Schedule 17 and Schedule 18 respectively, to maintain uniformity.
b) Minimum Disclosures: While complying with the requirements of Minimum disclosures, banks should ensure to furnish all the required information in ‘Notes to Accounts’. In addition to the minimum disclosures, banks are also encouraged to make more comprehensive disclosures to assist in understanding of the financial position and performance of the bank.
c) Summary of Significant Accounting Policies: Banks should disclose the accounting policies regarding key areas of operations at one place (under Schedule 17) along with Notes to Accounts in their financial statements. The list includes – Basis of Accounting, Transactions involving Foreign Exchange, Investments – Classification, Valuation etc, Advances and Provisions thereon, Fixed Assets and Depreciation, Revenue Recognition, Employee Benefits, Provision for Taxation, Net Profit, etc.
d) Disclosure Requirements: In order to encourage market discipline, Reserve Bank has over the years developed a set of disclosure requirements which allow the market participants to assess key pieces of information on capital adequacy, risk exposures, risk assessment processes and key business parameters which provide a consistent and understandable disclosure framework that enhances comparability. Banks are also required to comply with the Accounting Standard 1 (AS 1) on Disclosure of Accounting Policies issued by the Institute of Chartered Accountants of India (ICAI). The enhanced disclosures have been achieved through revision of Balance Sheet and Profit & Loss Account of banks and enlarging the scope of disclosures to be made in “Notes to Accounts”.
e) Additional/Supplementary Information: In addition to the 16 detailed prescribed schedules to the balance sheet, banks are required to furnish the following information in the “Notes to Accounts”: Such furnished (information should cover the current year and the previous year). “Notes to Accounts” may contain the supplementary information such as:
1)      Capital (Current & Previous Year) with breakup including CRAR – Tier I/II capital (%), % of shareholding of GOI, amount of subordinated debt raised as Tier II capital. Also it should show the total amount of subordinated debt through borrowings from Head Office for inclusion in Tier II capital etc.
2)      Investments: Total amount should be mentioned in crores, with the total amount of investments, showing the gross value and net value of investments in India and Abroad. The details should also cover the movement of provisions held towards depreciation on investments.
3)      Derivatives: Forward Rate Agreement/Interest Rates Swap: Important aspects of the disclosures would include the details relating to:
Ø  The notional principal of swap agreements;
Ø  Losses which would be incurred if counterparties failed to fulfill their obligations under the agreements;
Ø  Collateral required by the bank upon entering into swap s;
Ø  Nature and terms of the swaps including information on credit and market risk and the accounting policies adopted for recording the swaps etc.
4)      Exchange Traded Interest Rate Derivatives: As regards Exchange Traded Interest Rate Derivatives, details would include the notional principal amount undertaken:
Ø  During the year (instrument-wise),
Ø  Outstanding as on 31st March (instrument-wise),
Ø  Outstanding and not “highly effective” (instrument-wise),
Ø  Mark-to-market value of exchange traded interest rate derivatives outstanding and not “highly effective” (instrument-wise).
f) Qualitative Disclosure: Banks should discuss their risk management policies pertaining to derivatives with a specific reference to the extent to which derivatives are used, the associated risks and business purposes served. This also includes:
a)      The structure and organization for management of risk in derivatives trading,
b)      The scope and nature of risk measurement, risk reporting and risk monitoring systems,
c)       Policies for hedging and/or mitigating risk and strategies and processes for monitoring the continuing effectiveness of hedges/mitigants, and accounting policy for recording hedge and non-hedge transactions; recognition of income, premiums and discounts; valuation of outstanding contracts; provisioning, collateral and credit risk mitigation.
g) Quantitative Disclosures: Apart from qualitative disclosures, banks should also included the quantitative disclosures. The details are both Currency Derivatives and Interest rate derivatives.
h) Asset Quality: Banks’ performances are considered good based on the quality of assets held by banks. With the changing scenario and due to number of risks associated with banks like Credit, Market and Operational risks, banks are concentrating to ensure better quality assets are held by them. Hence, the disclosure needs to cover various aspects of asset quality consisting of:
Ø  Non-Performing Assets, covering various details like Net NPAs, movement of NPAs (Gross)/(Net) and relevant details provisioning to different types of NPAs including Write off/write-back of excess provisions, etc., Details of Non-Performing financial assets purchased, sold, are also required to be furnished.
Ø  Particulars of Accounts Restructured: The details under different types of assets such as (i) Standard advances (ii) Sub-standard advances restructured (iii) Doubtful advances restructured (iv) TOTAL with details number of borrowers, amount outstanding, sacrifice.
Ø  Banks disclose the total amount outstanding in all the accounts/facilities of borrowers whose accounts have been restructured along with the restructured part or facility. This means even if only one of the facilities/accounts of a borrower has been restructured, the bank should also disclose the entire outstanding amount pertaining to all the facilities/accounts of that particular borrower.
Ø  Details of financial assets sold to Securitization/Reconstruction Company for Assets Reconstruction.
Ø  Provisions on Standard Assets: Provisions towards Standard Assets need not be netted from gross advances but shown separately as ‘Provisions against Standard Assets’, under ‘Other Liabilities and Provisions – Others’ in Schedule No. 5 of the balance sheet.
Ø  Other Details: Business Ratios: (i) Interest Income as a percentage to Working Funds (ii) Non-interest income as a percentage to Working Funds (iii) Operating Profit as a percentage to Working Funds (iv) Return on Assets (v) Business (Deposits plus advances) per employee (vi) Profit per employee.
i) Assets Liability Management: As part of Assets Liability Management, the maturity pattern of certain items of assets and liabilities such as deposits, advances, investments, borrowings, foreign current assets, and foreign currency liabilities. Banks are required to disclose the information based on the maturity patterns covering daily, monthly and yearly basis.
j) Exposures
Break up Exposures: Banks should also furnish details of exposures to certain sectors like Real Estate Sector.
Exposure to Capital Market: Capital Market exposure details should be disclosed for the current and previous year in crores. The details would include direct investment in equity shares, convertible bonds, convertible debentures and units of equity-oriented mutual funds the corpus of which is not exclusively invested in corporate debt and also loan raised against such securities. A bank must also disclose the risk associated with such investments. The risks are to be categorized as Insignificant, Low, Moderate, High, Very high, Restricted and Off-credit.
Apart from the above category of exposures, banks are required to disclose details relating to Single Borrower Limit (SGL)/Group Borrower Limit (GBL) exceeded by the bank, and Unsecured Advances are to be furnished. Miscellaneous items would include Amount of Provisions made for Income Tax during the year, and Disclosure of Penalties imposed by RBI, etc.
Audit: The balance sheet and the profit and loss account of a banking company have to be audited as stipulated under Section 30 of the Banking Regulation Act. Every banking company’s account needs to be verified and certified by the Statutory Auditors as per the provisions of legal frame work. The powers, functions and duties of the auditors and other terms and conditions as applicable to auditors under the provisions of the Companies Act are applicable to auditors of the banking companies as well. The audit of banking companies books of accounts calls for additional details and certificates to be provided by the auditors.
Apart from the balance sheet audit, Reserve Bank of India is empowered by the provisions of the Banking Regulation Act to conduct/order a special audit of the accounts of any banking company. The special audit may be conducted or ordered to be conducted, in the opinion of the Reserve Bank of India that the special audit is necessary;
a)      In the public interest and/or
b)      In the interest of the banking company and/or
c)       In the interest of the depositors.
The Reserve Bank of India’s directions can order the bank to appoint the same auditor or another auditor to conduct the special audit. The special audit report should be submitted to the Reserve Bank of India with a copy to the banking company. The cost of the audit is to be borne by the banking company.
Financial Reporting Requirements of Insurance Companies in India
To protect the interests of policyholders and to increase transparency and credibility of insurance companies there is a need to have an effective regulatory system for financial reporting of insurance companies. Reporting requirements of insurance companies are different from that of other companies, because of the concept of policyholders and shareholders’ fund, segment reporting in respect of all the funds maintained by the company, complexity of insurance contracts and insurance itself is an intangible product.
Earlier the accounts of insurance companies were governed by Insurance Act 1938, but passing of Insurance Regulatory Development Authority Act (IRDA Act) in 1999 opened a new chapter for disclosure norms of insurance companies. In the year 2002, the IRDA came up with regulations for the preparation of the financial statements of insurance companies. According to the Insurance (Amendment) Act, 2002, the first, second and third schedules prescribed for balance sheet, profit and loss account and revenue account respectively as given in Insurance Act, 1938 have been omitted. Now revenue account, profit and loss account and balance sheet are to be prepared as per the formats prescribed by IRDA. However, the statutes governing financial reporting practices of insurance companies in India are: Insurance Act 1938, IRDA Act, 1999 (including IRDA Regulations), Companies Act and Institute of Chartered Accountants of India (ICAI).
IRDA Act 1999 (Including IRDA Regulations)
Insurance Regulatory Development Authority (IRDA) has prescribed various regulations from time to time. Preparation of Financial Statements and Auditor’s Report of Insurance Companies Regulations, 2002 are one of them. These regulations are related to the financial reporting practices of insurance companies. These regulations are important constituents of the Indian regulatory regime. According to the regulations made by the authority in consultation with the Insurance Advisory Committee, accounts of insurance companies are prepared according to the prescribed formats given by the authority. Details are given as under:
a) Preparation of Financial Statements: After the commencement of Insurance Regulatory Development Authority, Regulations, 2002, all the life insurance companies shall comply with the requirements of Schedule A and general insurance companies with Schedule B of these regulations while preparing their financial statements. The auditor’s report on the financial statements of all insurance companies shall be in conformity with the requirements of Schedule C. IRDA given the list of items to be disclosed in the financial statements of insurance companies under Part II of Schedule A (for life insurance companies) and Schedule B (for general insurance companies) of the (Preparation of Financial Statements and auditor’s report of Insurance Companies) Regulations, 2002. According to these regulations, following disclosure will form part of financial statements of insurance companies:
1.       Every insurance company will disclose all significant accounting policies and accounting standards followed by them in the manner required under Accounting Standard I issued by the Institute of Chartered Accountants of India. (ICAI).
2.       All companies will separately disclose if there is any departure from the accounting policies with reasons for such departure.
3.       Disclosure of investments made in accordance with statutory requirements separately together with its amount, nature, security and any special rights in and outside India.
4.       Disclosure of performing and non-performing investments separately.
5.       Disclosure of assets to the extent required to be deposited under local laws for otherwise encumbered in or outside India.
6.       All the companies are required to show sector-wise percentage of their business.
7.       To include a summary of financial statements for the last five years in their annual report to be prepared as prescribed by the IRDA.
8.       Disclose the basis of allocation of investments and income thereon between policyholders’ account and shareholders’ account.
9.       To disclose accounting ratios as prescribed by the Insurance Regulatory and Development Authority.
10.   Disclosure of following items is made by way of notes to balance sheet:
Ø  Contingent Liabilities.
Ø  Actuarial assumptions for valuation of liabilities for life policies in force.
Ø  Encumbrance’s to assets of the company in and outside India.
Ø  Commitments made and outstanding for loans, investments and fixed assets.
Ø  Basis of amortization of debt securities.
Ø  Claims settled and remaining unpaid for a period of more than six months as on the balance sheet date.
Ø  Value of contracts in relation to investments, for purchases where deliveries are pending and sales where payments are overdue.
Ø  Operating expenses relating to insurance business and basis of allocation of expenditure to various segments of business.
Ø  Computation of managerial remuneration.
Ø  Historical costs of those investments valued on fair value basis.
Ø  Basis of revaluation of investment property.
b) Management Report: According to the IRDA Regulations 2002, all the insurance companies are required to attach a management report to their financial statements. The contents of the management report are given under PART IV (Schedule A and Schedule B) of these regulations and reproduced below:
1.       Confirmation regarding the continued validity of the registration granted by the IRDA.
2.       Certification that all the dues payable to the statutory authorities has been duly paid.
3.       Confirmation to the effect that the shareholding patterns and the transfer of shares during the year are in accordance with the statutory or regulatory requirements.
4.       Declaration that the management has not directly or indirectly invested outside India the funds of the policyholders.
5.       Confirmation regarding required solvency margins.
6.       Certification to the effect that no part of the life insurance fund has been directly or indirectly applied in contravention of the provisions of the Insurance Act, 1938 (4 of 1938) relating to the application and investment of the life insurance funds.
7.       Disclosure with regard to the overall risk exposure and strategy adopted to mitigate the same.
8.       Operations in other countries, if any, with a separate statement giving the management’s estimate of country risk and exposure risk and the hedging strategy adopted.
9.       Ageing of claims indicating the trends in average claim settlement time during the preceding five years.
10.   Certification to the effect as to how the values, as shown in the balance sheet, of the investments and stocks and shares have been arrived at, and how the market value thereof has been ascertained for the purpose of comparison with the values so shown.
11.   Review of assets quality and performance of investment in terms of portfolio, i.e. separately in terms of real estate, loans, investments. Etc.
12.   A schedule payments, which have been made to individuals, firms, companies and organizations in which directors of the insurance company are interested.
13.   A responsibility statement indicating therein that:
a)      In the preparation of financial statements, the applicable amounting standards, principles and policies have been followed along with proper explanations relating to material departures, if any;
b)      The management has adopted accounting policies and applied them consistently and made judgements and estimates that are reasonable and prudent so as to give a true and fair view of the state of affairs of the company at the end of the financial year and of the operating profit or loss and of the profit or loss of the company for the year;
c)       The management has taken proper and sufficient care for the maintenance of adequate accounting records in accordance with the applicable provisions of the Insurance Act, 1938 and Companies Act 1956 for safeguarding the assets of the company and for preventing and detecting fraud and other irregularities;
d)      The management has prepared the financial statements on a going concern basis;
e)      The management has ensured that an internal audit system commensurate with the size and nature of the business exists and is operating effectively.
Non-Banking Financial Company
A Non-Banking Financial Company (NBFC) is a company engaged in the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issue by Government or local authority or other marketable securities of a like nature, leasing, hire purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of immovable property. A non-banking institution which is a company and has principal business of receiving deposits under any scheme or arrangement in one lump sum or in instalments by way of contributions or in any other manner, is also a non-banking financial company (Residuary non-banking company).
Section 451 (c) of the RBI defines “financial institution”, A non-banking company carrying business of financial institution will be an NBFC.
NBFCs lend and make investments and hence their activities are akin to that of banks; however there are a few differences as:
a) NBFC cannot accept demand deposits;
b) NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself.
c) Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.
a) NBFCs with assets of Rs. 100 crore and above were required to make additional disclosures in their balance sheet from the year ending March 31, 2009 relating to CRAR, exposure to real estate sector (both direct and indirect), and maturity patterns of assets and liabilities respectively. The above disclosures are now applicable for NBFCs-ND-SI (as redefined) and for all NBFCs-D. However, other NBFCs already disclosing the above are encouraged to continue to do so, in line with prudent practice.
b) All NBFCs-D shall additionally disclose the following in their Annual Financial Statements, with effect from March 31, 2015:
Ø  Registration/license/authorization obtained from other financial sector regulators;
Ø  Ratings assigned by credit rating agencies and migration of rating during the year;
Ø  Penalties, if any, levied by any regulator;
Ø  Information viz., area, country of operation and joint venture partners with regard to Joint Ventures and Overseas Subsidiaries; and
Ø  Asset liability profile, extent of financing of parent company products, NPAs and movement of NPAs, details of all off-balance sheet exposures, structured products issued by them as also securitization/assignment transactions and other disclosures.
a) A statement of all significant accounting policies adopted in the preparation and presentation of the balance sheet and the profit and loss account shall be included in the company’s balance sheet.
b) The accounting policies adopted in the preparation and presentation of financial statements shall be in conformity with the applicable prudential norms relating to accounting matters (including income recognition, asset classification and provisioning, and valuation of investments) issued by the Reserve Bank of India.
c) Where any of the accounting policies is not in conformity with the accounting standards and guidance notes issued by the Institute of Chartered Accountants of India, and the effect of departures from accounting standards/guidance notes is material, the particulars of the departure shall be disclosed, together with the reasons therefore and the financial effect thereof. Where such effect is not ascertainable, the fact shall be disclosed.
d) An inappropriate treatment of an item in balance sheet or profit and loss account cannot be rectified either by disclosure of accounting policies used or by disclosure in notes to balance sheet and profit and loss account.
e) Notes to the balance sheet and the profit and loss account shall contain only the explanatory material pertaining to the items in the balance sheet and the profit and loss account.
f) If the information required to be given under any of the items for which a separate schedule has not been prescribed herein cannot be conveniently included in the balance sheet or the profit and loss account itself, as the case may be, it can be furnished in a separate Schedule or Schedules to be annexed to and forming part of the balance sheet or the profit and loss account. This is recommended where items are numerous.
The Schedules referred to above, accounting policies and explanatory notes shall form an integral part of the balance sheet.
g) The figures in the balance sheet and profit and loss account shall be rounded off to the nearest thousands.
h) An NBFC having non-financial business shall also disclose all the additional information as required to be disclosed under Schedule VI of the companies Act.
i) For the purposes of these formats unless the context otherwise requires:
Ø  The expression ‘relatives’ shall have the same meaning as is assigned thereto in the Reserve Bank of India Act, 1934;
Ø  The expression ‘substantial shareholding’ shall mean the holding of 10% or more in the nominal value of the total subscribed capital of the company;
Ø  The expression ‘substantial interest’ shall mean:
1.       In a case where the concern is a company, beneficial ownership of its shares (not being shares entitled to a fixed rate of dividend whether with or without a further right to participate in profits) exceeding 10% in nominal value of the subscribed capital of such company;
2.       In the case of any other concern, entitlement to more than 10% of the profits of such concern;
3.       The expression ‘companies in the same group’ shall mean companies under the same management as defined below: Two companies shall deemed to be under the same management, if:
(i)      The managing director or manager of the one company is the managing director or manager of the other company; or
(ii)    A majority of the directors of the one company constitute, or at any time within the six months immediately preceding constituted, a majority of the directors of the other company; or
(iii)   Not less than one-third of the total voting power with respect of any matter relating to each of the two companies is exercised or controlled by the same individual or company; or
(iv)  The holding company is under the same management as the other company within the meaning of clause (i) clause (ii) or clause (iii) or
(v)    One or more directors of the one company while holding, whether by themselves or together with their relatives, the majority of shares in that company also hold, whether by themselves or together with their relatives, the majority of shares in the other company.
Ø  The expression ‘public deposits’ shall have the same meaning as is assigned thereto under the Non-Banking Financial Companies Acceptance of Public Deposits (Reserve Bank) Directions, 1998;
Ø  For determining whether the company and/or one or more directors of the company have a substantial interest in a concern, the interest of spouses and minor children of the directors of the company in such concern shall also be reckoned.

Ø  Every non-banking financial company shall prepare its balance sheet and profit and loss account as on March 31 every year. Whenever a non-banking financial company intends to extend the date of its balance sheet as per provisions of the Companies Act, it should take prior approval of the Reserve Bank of India before approaching the Registrar of Companies for this purpose. Every non-banking financial company shall finalize its balance sheet within a period of 3 months from the date to which it pertains”. 


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