“It's definitely an unusual move,” said veteran auditor Amarjit Chopra when asked about Indian Overseas Bank's decision to set-off accumulated losses against the share premium account balance.
Chopra, a former president of the Institute of Chartered Accountants of India, pointed out in a video discussion that company law does not permit such use of the share premium account balance. But banking regulation may provide a window of opportunity.
It is definitely an unusual move. There is no doubt about it. At least if I look at the companies act, that does not permit this kind of a treatment under any circumstances. But if I look at the Banking Regulation Act...and if I read sections 3 and 17, there is probably some way somewhere. But of course that has to be with the permission of the Reserve Bank of India and the other regulatory authorities.Amarjit Chopra, Former President, ICAI
R Subramaniakumar, the chief executive officer of IOB, told BloombergQuint in an interview that the bank had taken “relevant permissions”, but refused to specify whether it has sought and received permission of the Reserve Bank of India. He emphasised that the move was to present a true and fair picture of the balance sheet.
Ultimately, net value remains constant. It is a question of accounting practice, in order to bring a true and fair picture of the balance sheet which will facilitate the investor to take an informed view about it, rather than telling them that we have one hand in ‘plus' and the other in ‘minus', that we are setting off.R Subramaniakumar, CEO, IOB
The Companies Act, 2013 permits just five applications of funds in the share premium account. They include issue of bonus shares, buyback of securities, providing for premium payable on redemption of preference shares or debentures and expenses relating to issue of shares or debentures and expenses.
But the Banking Regulation Act, 1949 does seem to indirectly allow for other uses of funds in the share premium accounts of banks.
Where a banking company appropriates any sum or sums from the reserve fund or the share premium account, it shall, within twenty-one days from the date of such appropriation, report the fact to the Reserve Bank, explaining the circumstances relating to such appropriation.
A subsequent RBI circular in 2006 advises banks to seek prior approval of the regulator “before any appropriation is made from the statutory reserve or any other reserves”.
In a later interview Saswata Guha, director at Fitch Ratings, said this move will help IOB meet an upcoming coupon payment.
...if you look at distributable reserves for a bank like IOB, which is currently the weakest in the Indian banking sector. If you adjust those distributable reserves for the accumulated losses that are residing on balance sheets, it is highly likely that banks may not be in a position to pay off its coupons which are coming up in February, because the losses exceed the remaining distributable reserves which are residing on the balance sheet.Saswata Guha, Director, Fitch Ratings
A February 2017 RBI circular directed banks to pay coupons out of current year profits. In case of insufficient profits, banks could use other reserves (barring some like share premium account, revaluation reserve, etc...) after netting off accumulated losses and deferred revenue expenditure.
Guha said that perhaps this is how IOB and other banks, with soon-to-be-met coupon payments, will retain the ability to pay up.
“...because if these losses were to be set off then they will be not in a position to pay off their coupons”.
By setting off accumulated losses against the share premium account banks can ensure they have enough reserves to make coupon payments.
Chopra said this may be a precedent setting move by IOB and other banks may be tempted to adopt a similar route to set-off losses. It would be “alarming” if that were to happen, he added.
Guha held the same view.
IOB has sought shareholder approval for this decision by the board in an extraordinary general meeting to be held on January 30.
Watch BloombergQuint's conversation with IOB's R Subramaniakumar and Amarjit Chopra.
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