What’s behind the fiasco at IndusInd Bank?

Mumbai: IndusInd’s guarded statements. A flurry of accounting jargon. A maze of derivative deals behind the numbers. Social media chatter. Confusion. And then, the Reserve Bank of India‘s reassurance on a festive weekend. As the story plays out amid rating action and a 24% fall in the stock, the declaration of the bank’s derivative losses, estimated at more than ₹1,500 crore, has thrown up many questions.

What took the IndusInd management so long to declare the losses?

The dent in its books was caused by a September 2023 RBI communique spelling out how banks should value derivatives. It said all derivatives must be marked to market (MTM), which requires valuing assets and liabilities according to prevailing market price. Even though the circular became effective from April 1, 2024-and there was no requirement to book the losses in the 2023-24 balance-sheet-what held back the bank from reporting the losses in the June, September or December quarters of 2024? While derivative accounting is complex, it couldn’t have taken a year for IndusInd and its auditors to sense the jolt and come clean about it.

What caused the losses?
For years, as IndusInd mobilised deposits in dollars (and Yen) and cut deals to hedge the risks arising from exchange rate fluctuations, two departments of the bank followed different accounting rules. One showed upfront profits while the other staggered the losses over a period, said senior bankers and former officials who spoke on condition of anonymity due to the sensitivity of the matter. This generated a net gain. Once the RBI 2023 directive stopped this practice, losses which were deferred, thanks to the hitherto permitted accounting norms, suddenly piled up.

Here’s how it worked. Suppose the bank raised $100 worth of deposits at X%, a floating rate linked to the dollar, when the USD/INR exchange rate was 80. Since the bank lends in INR, and must pay back the depositor $100, it covers against a weaker INR. For this, the Liability Desk, which mobilised the deposit, passes on the forex risk to the Treasury Desk. This transaction is the ‘internal hedge’. The instrument used is called a cross-currency interest rate derivative. The Treasury then does a corresponding ‘external hedge’, by striking a foreign currency swap deal with another bank. With this swap, the Treasury hedges the forex and the rate risks on the interest as well as the $100 principal amount.

Suppose the treasury hedged at 81 a dollar-meaning even if INR declines to 90, it can still buy USD at 81. A year later, when the USD surged to 88, the Treasury showed an MTM gain of ₹7 (88 minus 81) under MTM accounting. Ideally, the Liability Desk should show a loss of ₹8 (88 minus 80), as it had raised $100 when USD/INR was 80. But it doesn’t as the liability desk does not follow MTM accounting.Instead, it follows accrual accounting, which allowed it to spread out the losses. For instance, for a 4-year $100 deposit, the liability desk books only a loss of ₹2 in the first year. Since the liability desk’s loss for 4 years is ₹8, for each year it accounts for a loss of ₹2-postponing the reporting of the balance ₹6 loss for the remaining three years. With this, the bank shows a net gain of ₹5 (the difference between the Treasury’s gain of ₹7 and the liability desk’s loss of ₹2). If the Liability Desk had also adopted MTM accounting (and considered the full loss of ₹8 in the first year itself), the bank would have reported a net loss of ₹1 (the difference between Treasury’s gain of ₹7 and the Liability Desk’s MTM loss of ₹8). Instead, it shows a gain of ₹5. So, for a deposit of $1 million, the bank books an MTM gain of ₹50 lakh (in this example).Is it therefore all about gaps in the accounting rule book?
Yes, and no. Since 2015-16, the guidance given by the Institute of Chartered Accountants of India (ICAI) says derivatives should be valued at MTM. If the bank and its auditors had adopted this, there wouldn’t have been any accrual accounting by the liability desk, and IndusInd shareholders would have been spared. But any ICAI guidance, though a framework for auditors, is only recommendatory in nature. It’s not mandatory, even though an auditor may have to explain why it didn’t follow it. While the bank was free to pick any accounting rule, it could have followed a single rule for both desks (either MTM or accrual) as a consistent governance practice. But following different rules generated MTM profits and pushed back accrual losses.

Interestingly, in June 2019, RBI had said that ICAI valuation standards should be followed for Rupee Interest Rate derivatives, but was silent about adopting MTM for forex derivatives. That came after 4 years.

Has IndusInd unwound the internal derivative deals?
It’s unclear. Was it in 2024-25? Which quarters? Did some of it happen before March 2024? Once a derivative which shows an MTM loss is unwound, the book losses crystallise into actual losses. (IndusInd did not respond to ET’s queries on whether some of the internal derivative deals are still on its books or why weren’t the losses reported earlier.)

How did divergent accounting escape the glare of multiple gatekeepers?
A bank’s book is scanned by statutory auditor, internal auditor and concurrent auditor, apart from RBI inspectors who spend weeks going through the numbers and minutes of meetings of asset-liability committee (ALCO). Did the auditors ever raise a red flag? What do the RBI inspection reports say? These questions need to be answered by the bank and regulators for greater transparency and improving trust in the banking system.