The recent disclosure by IndusInd Bank that its internal review of its assets and liabilities and derivatives portfolio had found discrepancies which could reduce its net worth by 2.5 per cent comes as a rude shock. While the management has tried to explain that the company will be able to bear the loss of around ₹1,600 crore, and that it will not impact capital adequacy or profitability in the coming quarters, it certainly raises questions about supervisory lapses.
The problem lay in the bank using its internal trading desk to hedge foreign currency risk in the balance sheet. The Reserve Bank of India (RBI) appears to have been aware of trouble brewing in this area, and had issued a circular in September 2023, asking all banks to discontinue internal trading of derivatives from April 1, 2024. IndusInd Bank’s internal review found discrepancies in accounting for these derivative transactions with the treasury and trading desk using different valuation methods for the derivative contracts. While the bank has been transparent in disclosing the loss to shareholders, it raises concerns about how accumulated losses went unnoticed for five to seven years. It shows gaps in the bank’s risk management and audit processes.
There have been other red flags concerning IndusInd Bank in recent past. The bank’s chief financial officer resigned abruptly, just ahead of the declaration of its third quarter results, citing a rather lame reason. In 2023 and 2024, the bank’s CEO and deputy CEO had sold large chunks of their holding in the bank. It is hoped that the report of the external advisor, due towards the end of this month, will provide clarity on the extent of governance/supervisory lapses at the bank, if any. With IndusInd Bank being a part of the Nifty50 and other popular indices, many mutual funds have been forced to buy the stock in the index funds and exchange traded funds tracking the index. This raises questions about the manner of selection of index constituents by stock exchanges, which is currently based primarily on market capitalisation. Fund managers have little choice but to buy index stocks, even if they have reservations on the governance or other operational aspects of the company. Index providers should consider assigning adequate weight to qualitative aspects of the business too, while choosing stocks for the indices.
The IndusInd Bank issue also raises concerns about the possibility of similar lapses in other banks while accounting for internal derivative trades. The central bank will have to carry out a review of all banks which have not been using external agencies for their hedging transactions, so that the full extent of the losses are divulged soon. The quality of the audit of banks books also needs to be examined. IndusInd’s books were subject to a bevy of audits including internal audit, concurrent audit, statutory and compliance audit and RBI audit. Yet, the losses remained unrecognised for several years. An ecosystem reappraisal is in order.
