Indusind bank - Accounting Saga

Accounting discrepancy which will turn a 1000 Crore profitable bank into a loss making one for the next quarter.

Imagine you are a sailor navigating through some unexplored territories of the sea. You need to protect your ship from unpredictable storms, but how do you do it?

In finance, companies face similar challenges with currency fluctuations and interest rates. They use derivatives to hedge these risks, and with these comes a lot of complexities in form of valuations and reporting.

The IndusInd Bank's Storm:

Nik, a NRI comes to India and deposits $10 Million in Indusind bank for 5 years, which is today valued at INR 80 Crs. (1$ = INR 80). Now there's a risk on the part of bank if INR depreciated over time? If after 5 years 1$ = INR 90, bank will have to pay back INR 90 Crs.

Understanding Derivatives:

Derivatives are like insurance policies for financial risks.

- Internal Hedging: This is like having a family member agree to cover your increased repayments if rates rise. It sounds convenient but doesn't actually transfer the risk outside your household.

- External Hedging: This is like buying insurance from a third-party company. If rates rise, the insurance company covers your increased payments, truly transferring the risk.

What Indusind Bank was doing was selling those $1 Million to another department in the same bank (Internal hedging), which was no hedging at all in substance. Treasury Department (TD) selling to Risk Management department (RMD) - which would further hedge the same in the market.

To make matters worse, the TD and RMD teams used completely different math - the difference in valuation methodologies of both the departments.

TD - using theoretical model eg. swap valuations.

RMD - using mark-to-market valuation (valuing the currency at market price).

The internal trade (TD hedge), meanwhile, was accounted for using swap cost accounting, affecting asset book instead of P&L.

RMD moved with the market, but TD followed theoretical models, which might not reflect market movements.

Continuing our exmaple: 

After 1 year 1$ = INR 85

Today RMD showed $10 Mn = 85 Cr.

But TD is still showing values calculating using Theoretical models.

At first - there was no hedge by TD.

Moreover - The reporting of both the departments differed creating discrepencies.

And as per the bank, these discrepencies in the derivative portfolio accumulated over 5-7 years to a massive INR 2100 Crs. before April 1 2024 when RBI asked the banks to re-examine their derivative transactions. Otherwise this would have been hidden below Accounting numbers for even longer period. This was like a lighthouse exposing hidden rocks in the sea.

The post tax impact may come out to be approx ~ INR1577 Crs which will have a direct impact on P/L.

Point to note - This amount is calculated by internal team. The amount calculated by external agency may be much higher. AND this whole saga brought a free fall in the share price of the bank of ~27%.