Banks' finances were badly hit in 2010-11 due to wage hikes and the new pension and gratuity policies. The three main developments affecting the finances of banks were: i) wage revision, providing for a 17.5 per cent increase; ii) providing for one more option to join the pension scheme; and iii) amendment of the Gratuity Act 1972, by increasing the ceiling of gratuity payable from Rs 3.5 lakh to Rs 10 lakh with effect from May 24, 2010.
These three developments, which are independent of each other, have resulted in substantial increase in the provisions to be made by the banks for their retirement benefits. The nature of impact and extent are different from each other as explained below.
Wage increase
Normally it is assumed that wages will increase every year by about 6 per cent. But when it increases by 17.5 per cent a heavy actuarial loss will arise, thereby increasing the provisioning to be made substantially. As per the Indian Accounting Standard 15 (AS-15), such losses have to be recognised immediately. Actuarial losses arise when the actual experience regarding wage increase, investment earning, and so on, vary from assumptions made while computing the provisioning to be made.
Pension option
This will not result in any actuarial loss but generate a new liability known as ‘past service cost', which arises when the bank introduces a new plan or improves the benefits payable under the existing plan. In such cases additional liability is created since the benefit is given with retrospective effect from the date of appointment of an employee.
This way the bank has to meet not only the liability arising during the current year but also those arising out of the entire past service of all employees. No doubt part of this liability will be covered by bank's contribution to PF and employees' one-time contribution of 2.80 per cent of monthly salary as per agreement. These two will broadly amount to 40 per cent of the corpus of the new pension fund leaving the balance 60 per cent to be made up by the bank. Thus the provisioning required to be made by the banks will be very huge.
Gratuity ceiling
The increase in gratuity ceiling from Rs 3.5 lakh to Rs 10 lakh will naturally increase the liability substantially. Here also past service cost is created since the increase is made effective retrospectively covering entire past service.
Thus banks will find themselves in a situation wherein the provisioning to be made for these additional benefits will be too huge to be met in one year. Considering that this huge burden has arisen because of the improvements in benefits applicable to entire past service and also considering the fact that the additional liabilities will emerge not all at once during this year but spread over the future years only, this writer had suggested that as a one-off measure banks be permitted to account for the increase as an expense on a straight-line basis over a period of five years starting March 31, 2011.
This suggestion has, by and large, been accepted by Reserve Bank of India, which recently issued a circular to public sector banks (PSBs) permitting them to amortise the increase in provision over a period of five years beginning March 31, 2011. The nature and extent of relief given by the RBI is dealt with below.
The relief
The relief given by the RBI by way amortisation is applicable only to the impact caused by the pension option and increase in gratuity limit from Rs 3.5 lakh to Rs 10 lakh. This is not applicable to the increase due to the wage hike of about 17.5 per cent and retired PF employees now opting for pension. Such increases are to be provided in full. In other words, the RBI has made a distinction between increase due to actuarial losses and increase due to creation of past service cost. Relief is available only for the latter and not the former
At first glance such a distinction between the impacts may appear anomalous. However, on a close examination it can be seen there is a logic behind such a distinction. The reasoning is that the pension option and increase in gratuity limit are totally unexpected developments. But wage hike is not an unexpected development as it is a well known fact that every five years there is a fresh agreement between banks and employees which results in an increase in wages.
The extent of such increase is also almost on an established pattern. AS-15 provides that while computing the liability in respect of various employee benefits by actuarial methods, the established practice of once in a five years wage hike pattern also has been factored in. This is in addition to other factors such as promotion, increments, increase in Dearness Allowance, and so on.
Accordingly, the provisioning made by the banks every year would have already been taken into account the normal increase as well as increase due to a once in five years wage increase. Thus it can be seen there is no valid ground for expecting relief on this score.
Another interesting aspect of the RBI circular is that the facility of amortisation is also not available in respect of PF optees who have already retired, that is,. those optees who are not employees but pensioners. This also sounds logical as in respect of pensioners there will be no future contribution, as in the case of employee-optees for whom contribution will be there to the pension fund due to diversion of banks' share of PF to the pension fund. Prudence requires that such liabilities, where there is no further contribution, are provided for in full at the inception itself. In any case the number of such cases will not be significantly large and increase in liability will be quite small compared to total provisioning.
Amount to be amortised
We will now see as to how the amount to be amortised is to be computed. In the first instance, the present value of obligation will have to be computed by the use of actuarial techniques. Such computation will take into account the age profile of the employees, salary levels as on March 31, 2011, expected future salary increase, pension increase and probabilities of early exits due to ill-health retirement/voluntary retirement/death, and so on.
It will also take into account Central Government bond rates as on valuation date for determining interest rate for discounting. Such estimation will be made for all employee benefits such as gratuity, pension (covering existing optees, new optees and pensioners), privilege leave, sick leave, leave fare concession, and so on.
From the total actuarial present value so arrived at for all benefits, the fair value of all the assets in the pension and gratuity funds will be deducted. The resultant figure thus arrived is called the liability.
This liability represents the additional provision to be made. This will include both the normal increase in provision as also the impact due to the three developments mentioned earlier. In the normal course, provision has to be made in its entirety. It is here that the RBI has come to the rescue of the banks.
Now to arrive at the provision to be amortised as per the RBI circular, we first estimate actuarial present value of the liabilities arising out of second pension option and increase in gratuity ceiling. For this purpose we carry out first a valuation of new PF optees (only optees and not retirees).
The next stage is to compute gratuity liability based on the Rs 3.5 lakh ceiling or bank scheme, whichever is better, and again on Rs 10 lakh ceiling or bank scheme, whichever is better. The difference between these two figures so arrived at represents the increase due to gratuity ceiling increase. Now we get the total impact due to second pension option and increase in gratuity ceiling. This is divided by five and this one-fifth is provided as on March 31, 2011.
Similarly this one-fifth is provided during each of the next four years and at the end of this period the whole amount would have been amortised. While this is normally what would have happened, the RBI circular contains another interesting clause which seems to give another relief after three instalments, that is, the one up to March 31, 2013, are amortised.
The implication of this clause seems to be as follows : As per the RBI circular, as on the date on which AS (15) is to converge with International Financial Reporting Standards (IFRS) viz., April 1, 2003, the unamortised amounts still remaining will be adjusted against the opening balance of reserves as on that date.
This means that the last two instalments will not actually be amortised and, therefore, will not be routed through the profit and loss account statement. What will happen is reserves will be reduced to the extent of last two instalments of unamortised portion. This will naturally hit the reserves and, consequently, the capital adequacy ratio.
Banks are required to keep this in view while planning their capital augmentation, suitably factoring in Basel III requirements. The RBI is in the process of issuing another circular on this point and only after that will there be better clarity on this clause.
An illustration
To have a better appreciation about the extent of impact and relief we shall go through a typical case of a bank. By way of illustration we shall take a bank with the following employee profile:
Total number of employees: 10,000 — with average age 48 years and total salary of Rs 25 crore a month
Number of existing pension optees — 5,000
Number of existing pensioners — 3,000
Number of PF optees who have opted for pension during 2010-11 — 5,000
Number of PF-retirees who have opted for pension — 750
On an actuarial computation made on appropriate basis it has been found that the three developments outlined will have an impact as shown in the Table.
It can be seen that of the total impact of Rs 840 crore only Rs 392 crore has to be reflected in the profit and loss statement.
This relief is quite reasonable and no doubt will be welcomed by all stakeholders. Though the above is only an illustration, the magnitude is not likely to be far removed from reality in many cases.
However, the only snag is that this relief is given only to public sector banks. Actually the problems faced by private sector banks are identical. It is, therefore, only logical that the relief be extended to them as well before March 31, 2011
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