in restructuring bank sacrifices interest rate for benefit of borrower so that he is back on track and this sacrifice should be quantified and accounted
see below explanation
As a Statutory Auditor, of a bank, how would you verify the “Sacrifice” on Non-Performing Assets for which Corporate Debt Restructuring has been undertaken?
(Background:- In CDR interest may be reduced to some extent to help borrower, in such scenario, banks sacrifice future interest income. But this sacrifice will go unnoticed if we simply book future income at reduced rate. As per RBI guidelines it is important to present this sacrifice in P&L. For this they specified provision for loss due to sacrifice of interest should be booked in P&L)
Provision for loss due to sacrifice of Interest in CDR =
PV of Future Interest Before CDR – PV of Future Interest After CDR
Discounting Rate = BPLR (Date of Restructuring) + Term Premium + Credit Risk Premium (Category of Borrower)
Sacrifice of Interest
The Revised Guidelines on Corporate Debt Restructuring (CDR) Mechanism specified that in case of rescheduling of accounts, the element of interest sacrifice to be computed in present value terms. The guidelines state that the sacrifice should be computed as the difference between the present value of future interest income reckoned based on the current BPLR as on the date of restructuring plus the appropriate term premium and credit risk premium for the borrower category on the date of restructuring and the interest charged as per the restructuring package discounted by the current BPLR as on the date of restructuring plus appropriate term premium and credit risk premium as on the date of restructuring.
Steps by Auditor
Accordingly, the following steps may be taken in this regard-
- Ascertain appropriate rate of discount.
- Check the appropriate credit risk premium for the specific borrower category for all restructured accounts.
- Check the computation of present value interest
- Computation of sacrifice amount.
- See that the entire amount should be written off(against interest receivable if any) or provided for in case sacrifice is positive.
- Verify provision of adequate security coverage of the loan in case restructuring of principal amounts.
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