The following is an extract of an article that appeared in The Economic Observer
ID: 2797639 • Letter: T
Question
The following is an extract of an article that appeared in The Economic Observer Online on July 21, 2008:
"Chinese commercial banks have been told by the government to waive loan repayments for Sichuan earthquake victims who are now unable to settle their bills.
The China Banking Regulatory Commission (CBRC) issued a notice on May 23 demanding banks to write off credit extended earlier to quake victims as bad debt if the borrowers met the following criterions: suffered huge economic losses from the Sichuan earthquake and failed to be compensated by insurance; or despite insurance compensation still fell short of repaying debts. CRBC says the reclassification has a legal foundation with the Ruling on Bad Debts Management for Financial Institutions (revised 2008).
The CRBC notice’s stated objectives were to ease the suffering of quake victims and create conductive environment for rebuilding efforts. However, industry sources said it was akin to transferring the economic losses incurred by the May 12 earthquake to commercial banks.
At present, it is still unclear how much the banks will have to own up to; but based on research by the BOC International (China) Limited, the Chinese banking industry may suffer losses between five and 13 billion yuan from the earthquake, while some market research institutions believed the losses could run well over 20 billion yuan.
" Questions:
• Explain the usefulness of the raising of an allowance for impairment of receivables to users of financial statements.
• Is the notice by the CBRC consistent with the measurement of receivables?
• Why do you think the CBRC would have issued this directive?
Explanation / Answer
*When Bank think that recovery of outstanding balance is in doubt they make special provision for it.In this case there is an objective evidence in the form of directive by top regulator that bank has to recognise impairment on all loan and advances to Sichuan earth quake victim. Bank make these provisions to safeguard against any capital deficiency. With provision or allowance for impairment a bank Income statement look as below-
Net income – 100
Ope exp – 60
Provision – 20
NP -20
Raising an allowance for losses help bank build capital as this provision part remain with the bank and there is no tax paid on it. But higher provision means less money is going toward shareholders as a dividend and it also means that bank are not able to perform their credit appraisal properly thus resulting in higher impairment. Generally user of financial statement takes higher provision as very negative sign because it show that non-performing asset are high.Earlier bank used to make provision against an NPA account.(NPA – an account that is not paying any int+principle for 90 days) but under IFRS 9 they need to make a dynamic provision for all account based on their Probability of default and Loss given default. In this case bank will definitely classify all Sichuan victim account as NPA or sub standard account and they will have to make provision on income statement. Although this is not due to some operational problem of the bank but regulatory diktat.
*As per IFRS and other accountings we measure receivable of bank, based on their credit quality.Credit quality of these account is now junk as all are eligible for complete loan waiver.So bank measure and do allowance based on this CBRC directive.Some account are coverd by insurance and this may reduce the Loss given default of bank.
*To provide instant relief to victims and it is like a bail out packeage to whole reason so that economic activity can pick up fast after such a big devastating earthquake.
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