CAB CALLING July-September, 2008

IFRS :
Implementation
Challenges
and
Approach for Banks in India
Russell Pavera*
Jamil Khatri**
In line with the global trend, the Institute of Chartered shared our views on some of the approaches that banks can
Accountants of India (ICAI) proposed a plan for convergence adopt to address these challenges and to ensure successful
with International Financial Reporting Standards (IFRS) for implementation of IFRS within the required timelines.
certain defined entities - including banks - with effect from
April 1, 2011. Convergence to IFRS would mean India would Specific Challenges for the Banking Sector
join a league of more than 100 countries, which have
converged with IFRS. In addition to the several challenges along the path to
convergence that are applicable to all companies, banking
We believe that for Indian banks, the financial impact of companies in India face certain additional challenges. These
convergence with IFRS will be significant, particularly, in include :
areas relating to loan loss provisioning, financial instruments
and derivative accounting. We also expect that in addition to l In addition to the general accounting standards and
the financial accounting impact, the convergence process is practices that constitute Indian GAAP, banking
likely to entail several changes to financial reporting systems companies are currently required to adhere to
and processes adopted by banks in India. These changes accounting policies and principles that are prescribed
would need to be planned, managed, tested and executed in by the Reserve bank of India (RBI). For example,
advance of the implementation date. Such changes are likely financial reporting policies for provision for loan losses
to be time consuming. In view of this, banks in India would and investments are specified by the RBI. Our
need to start considering a roadmap for convergence to experience indicates that adoption of IFRS requires a
IFRS, at the earliest. significant change to such existing policies and could
have a material impact on the financial statements of
For many banks, convergence with IFRS is expected to have banking companies.
a significant impact on their financial position and financial
performance, directly affecting key parameters such as l Application of IFRS in areas such as provision for loan
capital adequacy ratios and the outcomes of valuation losses and impairment of investments generally
metrics that analysts use to measure and evaluate requires a high level of judgment and would require
performance. significant changes in the financial reporting
processes (for example, to estimate cash flows that
Through this paper, we seek to share our perspectives on will be recovered including through sale of collateral).
some key financial reporting impact areas and challenges Our experience indicates that banking companies that
that would impact the banking sector in India. We have also are currently using accounting models that require

*Chief Executive officer and **Head - IFRS Services, KPMG-India. This is an edited extract of the article published in KPMG website.

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 CAB CALLING July-September, 2008
limited judgment (for example, due to prescribed
loss/provision rates) would face significant
challenges in incorporating some of the revised
accounting models into the financial reporting
system.
l Assuming that India converges with IFRS using the
transition provisions of IFRS 1, First-time Adoption of
International Financial Reporting Standards
(currently, there is discussion regarding whether IFRS
1 would be adopted for transition), several provisions
of IFRS would need to be retroactively applied,
subject to available exemptions under IFRS 1.
Current information systems (including IT systems) of
several banking companies may not be sufficient to
generate information required to retroactively apply
these standards.
l International Accounting Standard 39 (IAS 39) on
Financial Instruments. Recognition and
measurement along with its related guidance, is one
of the most complex and comprehensive accounting
pronouncements under IFRS. Substantially, all the
assets and liabilities of banking companies comprise
financial instruments that would be governed by the
provisions of IAS 39. Our experience indicates that
this poses significant complexity and application
challenges and results in significant volatility in the
income statement.
l Similarly, IAS 39 requires extensive use of fair
valuation. Given the economic environment and lack
of relatively developed financial markets for certain
foreign exchange and interest rate instruments,
application of these required fair valuation techniques
poses additional implementation challenges.
l By virtue of operating in a regulated industry, banking
companies are subject to regulatory reviews and
inspections and are also subject to minimum capital
requirements. As highlighted earlier, IFRS requires
increased use of judgment and extensive use of
unobservable valuation inputs and assumptions. The
regulatory review process would need to be adjusted
to acknowledge the inherent judgments involved in
the application of IFRS. Additionally, our experience
indicates that application of IFRS may result in higher
loan losses and impairment charges, thereby
impacting available capital and capital adequacy
ratios. Similarly, use of fair values would introduce
additional volatility in reported capital with its
consequent impact on capital adequacy.
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Banks in India need to start thinking through some of the
challenges highlighted above to develop a roadmap to meet
the challenges of convergence.
Top Five Technical Accounting Challenges for
Banks
1. Loan/ Investment Impairment
IFRS prescribes an impairment model that requires a case
by case (for significant exposures) assessment of the facts
and circumstances surrounding the recoverability and timing
of future cash flows relating to a credit exposure. Should
there be an expectation that all contractual cash flows would
not be recovered (or recovered without full future interest
applications), an account would be classified as impaired
and impairment be measured on present value basis using
the effective interest rate of the exposure as the discount
rate. For groups of loans that share homogenous
characteristics (such as mortgage and credit card
receivables), impairment can be assessed on a collective
basis. The aim of an individual or collective assessment is to
capture the incurred loss for a specified portfolio. General
provisions are permissible only to extent that they relate to a
specified risk that can be measured reliably and for incurred
losses. No provisions are permitted for future or expected
losses. For investments, a similar analysis is conducted, the
key difference being that the fair value of the investment is
also considered as an input in addition to the financial / credit
standing of the issuer.
The bedrock of this impairment assessment is a system that
considers all the facts and circumstances and requires the
use of informed judgment. This aspect represents the most
significant difference from Indian GAAP for banks in India.
Current Indian GAAP / RBI guidelines require a limited use of
judgment and are mechanistic nature with prescribed loss /
provision rates.
What should banks focus on to meet this challenge?
• Develop / strengthen a data capture system to enable
the impairment assessment after determining
tactically where information will be collected / who will
make the impairment assessment / templates and
information gathering and storage systems, etc.
• Use and align this process of information gathering
and assessment to strengthen the credit risk
management function and feed into other strategic

initiatives such as internal ratings, Basel II
compliance, and potential application of internal
ratings based/advanced approaches.
• Improve and strengthen the loss forecasting
mechanisms within the organization in parallel with
fine tuning risk adjusted pricing for fresh loans being
sanctioned by the bank.
• Certain system changes would need to be made for
accounting for impairment; for example, computation
of discounted future cash flows to facilitate the
booking of the required accounting adjustments.
2. Required Use of Fair Value for More Financial
Instruments
Fair value measurement is infrequently used under Indian
GAAP and in most cases where it is, the aim is primarily to
capture a lower of cost or fair value measurement base.
Under IFRS, there may be a significant increase in the extent
that fair value measurement needs to be used. For instance,
all financial assets and liabilities will need to be initially
measured at fair value. While in a number of instances, fair
values may be represented by transaction prices, the onus
on banks will be to prove that transaction prices represent
fair value. In addition, there will be a number of instances
where unrealized gains can/should be recognized (for
example, trading instruments and those where the bank
elects the fair value option). Further, due to the stringent
criteria prescribed under IFRS, a Held to Maturity (HIM)
classification, (which currently results in an amortised cost
valuation basis for a significant part of most Indian banks’
investment portfolio), is unlikely to be available leading to fair
value measurement for a substantial part of the portfolio.
Again, this is a significant shift from current accounting
treatment under Indian GAAP.
What should banks focus on to meet this challenge?
• Fair valuation methodologies and practices would
need to be re-examined to ensure that they are
current, up to date, and are validated and back tested
in the current market conditions
• Adequately trained personnel need to be made
responsible for this significant area of expertise and
judgment
• Profit planning and budgeting need to be fine tuned to
incorporate the expected increase in income
CAB CALLING July-September, 2008
statement volatility arising of the increased use of fair
values as a measurement attribute.
3. Derivatives and Hedge Accounting
Under IFRS, all derivatives are recognized on the balance
sheet at fair values with changes in fair values being
recognized generally in the income statement other than in
the case of a qualifying cash flow hedge relationship.
Application of hedge accounting does reduce the income
statement volatility induced by the fair value measurement of
derivatives but, comes with significant strings attached in the
form of documentation, hedge effectiveness testing and
ineffectiveness measurement. In addition, embedded
derivative contracts (such as equity conversion options
embedded in a convertible debenture - the most common
situation found in India) require to be separated from their
host contracts and be accounted for separately. In contrast,
current Indian GAAP does not specifically address the more
‘difficult to apply’ provisions of fair value and hedge
accounting.
What should banks focus on to meet this challenge?
• Derivative valuation models need to be validated and
back tested - their use will be much more significant in
the IFRS world.
• Hedge relationships are a specialized area of
accounting and it is crucial that organizational
awareness of the rules are enhanced. Certain
process and system changes need to be made (for
example, to designate hedging relationships at a
‘gross’ level and not at a ‘net’ level given that many
interest rate, foreign exchange and liquidity positions
are monitored only on a ‘net’ basis), documentation
and hedge effectiveness testing processes need to be
incorporated.
• Certain strategic decisions will need to be made as to
where and when hedge accounting is to be applied
(even perhaps what contracts are transacted in),
where individual banks will be comfortable with the
income statement volatility as it does not see value in
the cost benefit analysis of applying hedge
accounting.
4. De-Recognition of Financial Assets
Under IFRS, de-recognition of financial assets is a complex,
multi-layered area with the de-recognition decision
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 CAB CALLING July-September, 2008
dependent largely on
whether there has been
a transfer of risks and
rewards. If the
assessment of the
transfer of risks and
rewards is not
conclusive, an
assessment of control
and the extent of
continuing involvement
is required to be
performed. In many
cases, this cannot be
restricted to qualitative
assessments and
needs to be necessarily
a quantitative assessment.
A major area impacted would be securitization activity with
most Indian securitization vehicles are currently structured
to meet Indian GAAP de-recognition norms. All those
securitization vehicles would substantially collapse into the
transferor’s balance sheet and assets would fail the de-
recognition test under IFRS. For example, securitization
transactions, where credit collaterals are provided /
guarantee is provided to cover credit losses in excess of the
losses inherent in the portfolio of assests securitized, may
not meet the derecognition principles enunciated in IAS 39.
Given that the IFRS position is significantly different from
that followed under Indian GAAP, application of the new
norms would, in general, lead to more instances of transfers
failing the de-recognition criteria, thereby, resulting in large
balance sheets, capital adequacy requirements, lower
return on assets, and deferral of gains/losses on such
securitization transactions.
What should banks focus on to meet this challenge?
• Assess the impact of transactions that would fail de-
recognition and consider the potential impact on
capital adequacy and ratios such as return on assets.
• Work towards developing (in consultation with
investors, originators and legal counsel) new
securitization structures that are designed to meet the
de-recognition norms under IFRS.
• Assess at a strategic level if the organization is willing
to compromise on credit ratings for securitized pools in
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order to achieve the desired capital and accounting
result of de-recognition.
• Certain process and system changes will need to be
made for accounting for these transactions from
current practice (including for example, how an
assessment of transfer of risk and rewards will be
measured and documented).
• Create an assessment model that incorporates the full
cost benefit analysis of undertaking securitization
transactions even if they don’t meet the de-recognition
norms as a funding alternative to raising deposits.
5. Consolidation of Entities
Under IFRS, consolidation is not driven purely by the
ownership structure of an entity. Instead, the focus is more
on the power to control an entity to obtain economic benefits
- this power to control could be expressed as ownership of
equity securities but is not limited to it. For instance, this will
include a consideration of currently exercisable potential
voting rights / shares; management and other agreements,
de facto control and other arrangements that provide the
power to control an entity. IFRS also provides guidance on
how consolidation decisions for special purpose entities
should be arrived at. In a number of ways, IFRS provides
more rigorous consolidation tests and in practice can result
in the consolidation of a larger number of entities as
compared to Indian GAAP which focuses on a narrower set
of tests (majority of ownership and control over a majority of
the composition of the board of directors or similar body).
What should banks focus on to meet this challenge?
• Collate and inventorise the full set of entities where
consolidation assessment need to be made and
perform those assessments as early as possible
including a consideration of non shareholding related
factors that impact consolidation.
• Ensure that common accounting policies are applied
across the group.
• Prepare for the impact of factors arising out of
consolidation such as how disclosures at a group level
can be collated and populated, chart of accounts,
group reporting packages, reporting timelines.
• Consider specifically how inter-company transactions
and deferred taxation related aspects will be dealt with.

Questions to Consider
As discussed above, IFRS implementation is likely to have a
significant impact for most banks. Based on our experience
with several large IFRS implementation projects, we have
summarized our thoughts and perspectives on some
important questions that banks may wish to consider while
developing a plan for IFRS implementation.
What are the advantages of starting early in
implementing IFRS ?
A significant advantage in being on early adopter is that you
are better suited to confront the myriad of tactical and
strategic decisions (e.g. impact on existing operations and
information systems, impact on other technical or strategic
initiatives currently under way at your bank) that would need
to be made as the project progresses.
Starting early would also enable you to better manage the
expectations of internal stakeholders such as the Board of
Directors and senior management, regulators and external
investors and analysts about the impact on earnings and
equity. This can also enable you to determine any potential
need for additional capital that you may need on mandatory
adoption of IFRS at a future date.
There are a number of other key reasons why starting early is
important. One is the need to create time to consider the true
commercial implications of alternative accounting
treatments. Another is to do a complete dry run of accounting
systems and the end-to-end reporting process before the
actual conversion.
What are the top three risks to an effective IFRS
implementation project ? How should we manage
them ?
There are a multitude of risks that we have encountered over
our broad experience of managing these engagements
globally. It is challenging to separate out three specific ones
but based on the key differentiators of successful and less
successful projects, we would like to highlight the following
three :
i) Sufficient dedicated internal staff : The single biggest
differentiator of successful and less successful
conversion projects is the presence or absence of
project management arena.
CAB CALLING July-September, 2008
ii) Failure to spend sufficient time and energy on 'impact
assessment' : We believe that the initial impact
assessment is by far the most critical phase of the
project. It is essential that banks plan for this phase
and allow sufficient time to ensure that the gap
analysis is conducted on a line-by-line basis through
the income statement and balance sheet. The gap
analysis feeds the systems changes, the training
program and the accounting policies - only realising
that elements of this have been missed later in the
conversion process, leads to expensive unwinding of
activities.
iii) Failure to train staff to a sufficient standard : Many
organisations that we have encountered
underestimated the level of investment required in
training their finance community. A comprehensive
training strategy and program is a complex area and
needs to be carefully considered.
Who else should we be involving in this
conversion process beyond the finance team?
Since an IFRS conversion is much more than an accounting
project, we would expect to see - in addition to core members
of the finance function - representatives from the following
areas and functions of the organization.
l Steering commmittee : Plays in important role in
signing off on accounting options where treatments
vary and can have different effects on the business
from a commercial point of view.
l Information technology : Getting the finance function
and the IT function to talk to each other is critical as
accounting and disclosure gap differences are
translated into systems functionality changes.
l Divisional business heads : Treasury, internal audit
and business sector heads within each division are
critical to ensuring commitment and sponsorship
within each divisional sub-project.
l Human resources : Plays a major role in the global
training program, which can be a complex logistical
exercise with various strategies open to how you
choose to roll out training to your finance and
business community.
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What is the optimal use of external advisors and heterogeneous your IT systems, the more tailored local level
specialists on such a project? systems changes will be required to ensure the right data is
being collected for implementing IFRS (including retroactive
application on first-time adoption).
This is a significant
amount of work and
The mapping of your chart of accounts to take into
internal specialist
consideration the new format of your reports and accounts
resources are typically in
can also be a considerable challenge for organizations of
short supply so we see
your size and complexity. This activity should be kicked off at
companies using a
a conceptual level as early in the process as possible.
combination of internal
and external resources to
We have seen some organisations attempt to manage their
address the specialist
IFRS conversion off-line at first using Excel spreadsheets
needs.
with a medium-term strategy to embed more sustainable
and repeatable systems solutions into the organisation over
Using an external
the longer term. This can be a risky strategy as off-line
specialist advisor provides
spreadsheets can become cumbersome and extremely
an objective voice to all the
difficult when attempting to consolidate a lot of information.
very difficult assessments
Be sure to understand the functionality of your consolidation
which are often under-
system and be clear as to the degree of change required to
estimated by the internal
make it fit for purpose in relation to IFRS consolidation
specialists. Our
activity.
experience also suggests
that using an external
The key, therefore, is not to underestimate the investment
specialist team with experience during the actual conversion
that may well need to be made on the systems side of the
process assists in making your execution more successful.
conversion process. Critical to understanding the magnitude
of work involved will be a thorough gap analysis that takes
How do we ensure effective knowledge transfer to
into account the systems implications of the accounting
our team members?
differences that are being uncovered. A frank assessment
needs to be made at an early stage as to whether the bank is
Knowledge transfer is essential to ensure your ability to
looking at systems enhancements or a major overhaul.
embed IFRS as business-as-usual. Knowledge transfer
from external advisors and internal specialists to other
What should be disclosed externally and when?
internal team members should continue through the term of
the conversion project.
There is no need to be secretive about the results you are
generating under IFRS, assuming you are comfortable with
Training is a key element of a successful conversion project.
them and that you are able to tell a sensible story around
Training is needed for internal staff to help ensure proper
them.
understanding of the IFRS guidance and you should
incorporate significant amounts of training in your approach
As a general practice, we would recommend that you
and plan. Elements of training include workshop-based
consider being proactive in disclosing information on the
training for more complex and specific aspects of IFRS such
progress you are making on your project as soon as it makes
as financial instruments or share based compensation on
sense and you are comfortable to do so. Your project team
income taxes, or different media such as web-enabled
should also pay very close attention to emerging guidance
training to reach a broader audience.
from the ICAI, RBI and other related regulatory
developments.
What are the IT system-related challenges in
implementing IFRS? External analysts will not understand IFRS in the early
stages of conversion and, therefore, you may want to
Challenges relating to systems changes resulting from IFRS consider providing internal awareness sessions for them to
can be quite significant, especially in organizations with ensure they appreciate not only how results change, but why
disparate source systems at the local entity level. The more they change. The more you manage their expectations, the

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more likely it is that they will not be surprised when published The application of
numbers are released. new policies is a
critical challenge and
How do we keep the internal teams and sponsors you should look to
fully apprised of project progress? How do we address these in
several ways during
ensure all new policies are implemented
the conversion
consistently?
exercise. We have
often seen the
The project manager is responsible for establishing a clear
drafting of accounting
understanding of the types of communication channels that
policies accompanied
work within the bank and then using these to ensure the
by the development of
IFRS messages and progress updates are clearly
an overall accounting
communicated to all relevant stakeholders. Channels may
manual that also
include, but not be limited to, project news letters, email
c o n ta i n s s p e c i f i c
alerts, and a dedicated intranet site for the project. Forms of
sections relating to
mass communication will be punctuated with specific and
policy application.
focused IFRS conferences and locationbased face-to-face
communications.

Convergence with IFRSs - Benefits

The economy: As the markets expand globally the need for convergence
increases. The convergence benefits the economy by increasing growth of its
international business. It facilitates maintenance of orderly and efficient capital
markets and also helps to increase the capital formation and thereby economic
growth. It encourages international investing and thereby leads to more foreign
capital flows to the country.

Investors: Investors want the information that is more relevant, reliable, timely and
comparable across the jurisdictions. Financial statements prepared using a common set of accounting
standards help investors better understand investment opportunities as opposed to financial statements
prepared using a different set of national accounting standards. For better understanding of financial
statements, global investors have to incur more cost in terms of the time and efforts to convert the financial
statements so that they can confidently compare opportunities. Convergence with IFRS contributes to investors'
understanding and confidence in high quality financial statements.

The industry: The industry is able to raise capital from foreign markets at lower cost if it can create confidence in
the minds of foreign investors that their financial statements comply with globally accepted accounting
standards. With the diversity in accounting standards from country to country, enterprises which operate in
different countries face a multitude of accounting requirements prevailing in the countries. Convergence of
accounting standards simplifies the process of preparing the individual and group financial statements and
thereby reduces the costs of preparing the financial statements using different sets of accounting standards.

The accounting professionals: Convergence with IFRS also benefits the accounting professionals in a way that
they are able to sell their services as experts in different parts of the world. The thrust of the movement towards
convergence has come mainly from accountants in public practice. It offers them more opportunities in any part
of the world if same accounting practices prevail throughout the world. They are able to quote IFRS to clients to
give them backing for recommending certain ways of reporting.

(Source: Concept Paper on “Convergence with IFRS in India” by The Institute of Chartered Accountant of India)

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