Lessons from Indus Ind Bank episode

IndusInd Bank has come under scrutiny after reporting accounting mismatch of Rs. 1,577 Cr (post tax) arising from discrepancies in derivative transactions (estimated at 2.35% of the bank’s net worth as at the end of Dec, 2024)), on March 10, 2025.

“As per auditor-reviewed financial results of the bank for the quarter ended December 31, 2024, the bank has maintained a comfortable capital adequacy ratio of 16.46 per cent and provision coverage ratio of 70.20 per cent,” the RBI said. The liquidity coverage ratio (LCR) of the bank was at 113% as on March 9, 2025, as against regulatory requirement of 100%.

The RBI’s “Classification, Valuation and Operation of Investment Portfolio of Commercial Banks (Directions), 2023,” rules, came into effect from April 1, 2024. While most other banks compiled with the rules by June 2024, IndusInd Bank couldn’t do it until November last year, ballooning the losses.

“The Board and the management have been directed by Reserve Bank to have the remedial action completed fully during the current quarter viz., Q4FY25, after making required disclosures to all stakeholders,” RBI said.

The bank had obviously failed to comply with the “mark-to-market principle, a crucial accounting principle that requires foreign exchange assets and liabilities to be reported at their current market value. Losses on revaluation of foreign exchange liabilities should have been reported in line with accounting regulations. By neglecting to apply this standard, it contributed to a misrepresentation of the financial data, bank’s profitability and foreign exchange liabilities.

Some of the major guidelines spelt clearly by RBI in their circular dated 12^th September, 2023 are as under:

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 Internal Control System

There shall be a clear functional separation of (a) trading, (b) settlement, (c) monitoring and control, and (d) accounting. There shall be a functional separation of trading and back-office functions relating to banks’ own Investment Accounts, Portfolio Management Scheme (PMS) Clients’ Accounts and other Constituents (including brokers’) accounts.

Half-yearly review (as of March 31 and September 30) of the investment portfolio shall be undertaken by the banks which shall be placed before their Boards within two months, i.e., by end-May and end-November. The review shall cover, at the minimum, operational aspects of investment portfolio, amendments made to the Investment Policy, major irregularities observed in all audit reports, position of compliance thereto and certify adherence to laid down internal Investment Policy and procedures and the Reserve Bank guidelines.

Treasury transactions shall be separately subjected to concurrent audit by internal auditors and the results of their audit shall be placed before the Chief Executive of the bank once every month.

The ACB (Audit Committee of the Board) shall keep the Board informed about the overall exposure to capital market, the compliance with the Reserve Bank and Board guidelines, adequacy of risk management and internal control systems.

At the time of transition to these directions (i.e., on April 1, 2024), banks shall reclassify their investment portfolio as at March 31, 2024. Banks shall make suitable disclosures of the transitional adjustment made in their notes to the financial statements for the financial year ending March 31, 2025.

Compliance with the policies and procedures shall be fully documented and subject to periodic (at least yearly) internal audit and the results shall be available for supervisory review.

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It is apparent that Indus Ind Bank did not comply with the above guidelines, both in letter and spirit. The Bank CFO Mr. Jain left on January 17 this year and the bank said in an exchange filing that Jain had put in his papers “to pursue other professional opportunities”.

On March 7, three days before the derivatives losses were disclosed, IndusInd Bank received the RBI’s approval to reappoint Mr. Kathpalia as its MD and CEO – but just for one year, from March 24, 2025, to March 23, 2026. In September last year, IndusInd Bank’s board of directors had recommended a three-year term for its MD & CEO.

It is a common practice to thoroughly review the treasury operations and foreign exchange liabilities of the banks on an ongoing basis not only by the bank’s internal control but also by concurrent audit and at periodical intervals by statutory auditors, Audit Committee of the Borad that is part of corporate Governance compliance.

This episode at Indus Ind Bank not only highlights the failure of internal control to ensure proper compliance of RBI’s directives dated 12^th September, 2023 with respect to accounting of the derivatives transactions but also failure to point out the lapses in their internal control reports. Audit Committee of the Board is equally responsible for their lapses on Corporate Governance disclosures, while the primary responsibility rests with the treasury head and CFO. The statutory auditors of the bank too are responsible from March, 2024 onwards for this episode. From the information available in the public domain, it appears that in Dec-24-Jan-25 this episode came to light during the internal review at the bank. The Central Banker, RBI who is known as the lender of the last resort to save the banks in financial crisis, in this Indus Ind Bank case has to play a different role of the rescuer of the last resort, with a damage control exercise.

On 21^st March, 2025 IndusInd Bank has said that its board of directors have decided to appoint an independent professional firm to conduct a comprehensive investigation to identify the root cause of the discrepancies found in the derivatives portfolio. The independent firm will also assess the correctness and impact of the accounting treatment of the derivatives contract, and also identify any lapses and establish accountability for the discrepancies. NFRA (National Financial Reporting Authority) is entitled to take necessary disciplinary action in this regard, independently. Chairman of the Bank Mr. Ashok Hinduja reassured investors that the bank would receive full support if any capital requirement arose.

Post liberalisation in 1990s, RBI has delegated greater powers to the Banks and reiterated on several occasions that the banks have to strengthen their internal controls in order to ensure a greater degree of self-regulation. Punjab National Bank’s Nirav Modi’s fraud (2018) exposed the gaps in internal control of the bank, whereas Yes Bank episode (2020) and the current episode in Indus Ind Bank exposed the gaps in both internal control and Corporate Governance of these banks. It is ironical that tough there are several checks and controls at various layers, instead of functioning independently, the people at various layers assume that others have taken care of the things and go by their certifications, which is the root cause of problem.  

It is a welcome sign that The Reserve Bank of India has launched an industry-wide review of derivative positions of different banks, after the Indus Ind Bank episode. However, there is a need to infuse more proactive approach in the regulatory and supervisory functions of RBI. After the PMC Bank scam, in 2020 cooperative societies (i.e., cooperative banks) engaged in banking activities have been brought under the supervision of the Reserve Bank of India.  Cooperative banks come with less capital, large shareholder and depositor base from rural areas saddled with local political interference cum influence. In this process there is a danger of the banking regulator “missing the wood for the trees” in its supervisory role.

Therefore, there is a need to restructure the existing banking supervisory model to meet these challenges head on.

In this context the author repeats his suggestions (vide Issues and Challenges in supervision of cooperative banks for RBI, published in Hindu Post on October 13, 2020) as under.

1. The current agricultural refinancing functions of NABARD can be transferred to a separate entity which is floated for this purpose. 
2. NABARD can take up the primary inspection and direct supervision of the cooperative banks.
3. RBI may retain the overall supervisory function of the cooperative banks and exercise the option of conducting random inspections as and when it deems fit on an ongoing basis. 
4. People with political back ground to be disqualified from becoming the board members of cooperative banks and suitable guidelines to be framed to induct professionals into the board. 

Let us hope that both the government and the banking regulator will deliberate, discuss and decide a suitable course of action to ensure that the banking regulators do not quite often “Miss the wood for the trees” and will ensure a more proactive approach in the regulatory and supervisory functions of RBI, which is the need of the hour.