IndusInd Bank Clarification Leaves Too Many Questions Unanswered

Private sector lender IndusInd Bank's efforts to explain away its Rs 1,520 crore hit on the balance sheet owing to "discrepancies" in its derivatives book have muddled an already complex accounting issue.On Monday evening, IndusInd Bank explained that the so-called discrepancies were discovered somewhere around October 2024. After that, the bank conducted an internal review, appointed an external agency to verify its review, and informed the banking regulator about it. The public disclosures only happened this week, though.Three senior bankers NDTV Profit spoke to were not able to explain whether the management's explanation can be taken at face value at all. It is surprising that internal controls at the bank did not flag this issue off sooner, they said. These bankers spoke on conditions of anonymity.Here are some of the questions that are currently unanswered, despite the bank's clarifications..Why & How Did This Happen?IndusInd Bank's MD & CEO Sumant Kathpalia explains that there were long-tenure foreign currency borrowings on the bank's book. To better manage the liability and use it for local lending, the lender would often convert these borrowings to rupee liquidity.This would be done through a two-pronged transaction. The first one is an internal conversion by the asset liability management desk of the bank, and the second is an external hedge on the transaction undertaken by the trading desk.According to Kathpalia, the internal leg of the transaction would be at swapped cost, and the external leg was on a mark-to-market basis. Typically, these two costs are different for the duration of the contract but eventually converge when the contract matures.Now here comes the first key question. Why was the internal leg not marked to market?Typically in these foreign currency contracts, you would want to mark the transaction to market because currency moves over time. If these are long-tenure borrowings, the underlying currency is bound to be repriced.A senior official at another private bank explains that typically these internal transactions are regularly marked to market to ensure that no undue trading profit is being booked.When a bank buys a hedge against a foreign currency transaction, it regularly marks it to market value to show the real value of the underlying asset. In an ideal scenario, the bank would do it on the internal leg as well, as these are connected to each other, the banker explained.Another relevant question here is, why were internal or external auditors unable to pinpoint this previously?The derivative trade discrepancy has a direct bearing on past financial results. Was the bank stating incorrect treasury or investment gains for the first nine months of FY25?.These issues go to the core principles of accounting. If a transaction has two faces, one facing internally and one externally, they need to be balanced.Unless your internal controls are extremely weak, there is no way that an internal auditor or the finance team did not flag this off to the bank's leadership much before October 2024, the first banker said. Even for small contingent liabilities that remain unaccounted for, finance and treasury teams raise alarms and address them in normal circumstances.According to details given in the bank's annual report for FY24, mark-to-market receivables on derivative contracts during the year added up to Rs 6,885.61 crore for the bank. Mark-to-market payables on derivative contracts were not disclosed as they were less than 1% of the bank's total income for the year.To be sure, IndusInd Bank's total income was Rs 55,144 crore for the financial year ended March 31, 2024. This implies that the net payable mark-to-market on derivative contracts was under Rs 551 crore.As of March 31, foreign currency assets for the bank were at Rs 26,861 crore, while foreign currency liabilities were Rs 52,106 crore, according to the last available annual report..When Did This Happen?The bank contends that it discovered these gaps in the derivatives book in October 2024. It also says that since then it has been trying to ascertain the impact of the event since then.The clear question that emerges is why the bank was not able to disclose that there was a gap in its financial position sooner than March 10.The second banker quoted above said that this argument does not hold water. Notional values are always going to be high, but it is the bank's responsibility to know that its contingent liability on the hedge has not been squared off on its books.Another deficiency in the bank's clarification seems to be the reference to RBI's master circular on bank investment books. This master circular was issued in September 2023, and according to the bank's clarification, it barred internal trades by banks effective April 1, 2024.If the RBI's guidelines were effective in April 2024, why was the bank only able to find the discrepancy six months later, in October 2024?The second banker pointed out that at no point does the RBI's master circular refer to or bar any internal trades by banks. It is unclear what portion of the circular IndusInd Bank is referring to.Internal trades are a common practice across banks; however, the internal leg of these transactions is duly evaluated on prevailing market conditions, this banker explained.To be sure, the RBI's master circular only refers to derivative contracts in the context of how to report such transactions. Accounting for such transactions is based on the guidance book by the Institute of Chartered Accountants of India, which was last amended in 2021.While the bank's clarification says that such transactions have been conducted regularly over the last seven years or so, the chart above makes it clear that foreign exchange liabilities shot up largely in the last two financial years. In its annual report, IndusInd Bank has described how it handles foreign currency derivative transactions on its books."Derivative transactions designated as “hedges” are accounted on an accrual basis except the swap designated with an asset/liability that is carried at market value or lower of cost or market value," the FY24 annual report notes. "In that case, the swap is marked to market with the resulting gain or loss recorded as an adjustment to the market value of the designated asset or liability."If the bank's position on valuing swaps is clear, then why is there a large hit reported by IndusInd Bank?.What Happens Next?Already, the banking regulator has refused to give Kathpalia a three-year term, despite the board recommending it. Instead, the regulator extended his term by just one year, to March 2026.Is the regulator making it clear that a leadership change is warranted at IndusInd Bank?Kathpalia himself believes so. During the analyst call on Monday, he said that the RBI seems uncomfortable with his leadership skills. He also said that it is now up to the board to decide on a successor, if they choose to do so. He said he will remain committed to the bank till the last day of his extended tenure.But the other important question is, would the RBI conduct a deeper check into IndusInd Bank and other lenders after these revelations?According to the third banker quoted above, most lenders are preparing for this outcome. It is likely that the RBI might increase scrutiny of bank audit functions, their treasury portfolio, and positions in the currency market, his banker said.The questions raised in this story have also been sent to IndusInd Bank. This story would be updated with responses if the bank chooses to respond to them..In This Economy… IndusInd Bank’s Derivative Discrepancies Shake D-Street

IndusInd Bank Clarification Leaves Too Many Questions Unanswered

Here are some of the questions which are currently unanswered, despite the bank's clarifications.

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IndusInd Bank Clarification Leaves Too Many Questions Unanswered

Here are some of the questions which are currently unanswered, despite the bank's clarifications.

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