25 May 2017 12:38 IST

RBI stance on forex accounting hurts banks

Circular on ‘exchange gains’ recognition may dent profits

The RBI has been busy issuing numerous directives and circulars for banks on the bad loans front over the past couple of months.

But there was a low-key circular issued by the RBI last month, which has material implications for banks with foreign branches.

The circular issued guidelines clarifying the treatment of the foreign currency translation reserve (FCTR) relating to non-integral foreign operations, as per Accounting Standard (AS) 11.

If the RBI had applied these guidelines with retrospective effect, they would have dragged down ICICI Bank’s profits in FY16 by about ₹940 crore and Bank of Baroda’s profits by about ₹303 crore.

For FY17, the RBI’s circular has robbed these banks of an additional income boost of over ₹280 crore in the case of ICICI Bank and ₹193 crore in the case of Bank of Baroda.

What AS 11 states

AS 11 provides guidance on translation of the financial statements of foreign operations. Exchange difference on translation of financial statements of a non-integral foreign operation is accumulated in the Foreign Currency Translation Reserve (FCTR).

Only on full or partial disposal of the non-integral foreign operation (through sale, liquidation, repayment of share capital or abandonment of all or part of that entity) can the amount in the FCTR be transferred to the Profit and Loss account as a gain or a loss. Also, payment of a dividend is considered to form part of a disposal only when it constitutes a return of the investment.

“Accordingly, when there is repatriation from non-integral foreign subsidiaries or branches, first a determination is to be made whether such foreign currency repatriation represents return of investment (the capital investment) or return on investments (dividends, profits),” explains Sumit Seth, Partner, Price Waterhouse & Co.

“Reclassification of accumulated FCTR balance to the Profit and Loss (account) is permitted in case of the former type of repatriation, that is, where there is return of investment which may be considered as a partial disposal of the foreign operation,” he added.

The RBI circular observed that banks have been recognising gains in their Profit and Loss account on repatriation of accumulated profits/retained earnings from overseas branches by treating the same as partial disposal under AS 11.

It clarified that the repatriation of accumulated profits “shall not be considered as disposal or partial disposal” of interest in non-integral foreign operations as per AS 11, and banks should not recognise such gains or losses in FCTR in the Profit and Loss account.

Impact on banks’ earnings

The guidelines have implications for a few banks that have been recognising gains on repatriation of funds by their overseas branches.

ICICI Bank, in its latest March quarter results, stated that it had reversed foreign exchange gains amounting to ₹288 crore in Q4 of FY17, which had been recognised as other income in the nine months to December 2016.

Bank of Baroda said it has not recognised exchange gains of ₹193 crore as income arising from repatriation of funds from foreign offices in FY17. There were no gains recognised during the nine-month period ended December 2016 requiring reversal, according to the management.

Lacks clarity

The circular, however, is silent on whether the guidelines apply retrospectively.

ICICI Bank had recognised ₹940 crore in FY16, as exchange gains in the P&L account on account of repatriation. This was nearly 10 per cent of its profits that year. Bank of Baroda had reported a loss of about ₹5,400 crore in FY16. If the ₹303-crore exchange gains that Bank of Baroda recognised on repatriation were excluded, its losses would have been steeper.

But the bank said that in the management’s opinion, the circular is not retrospective in nature, and it has applied the guidelines from FY17.

(The article first appeared in The Hindu BusinessLine.)