annual-report-FY2021

289 MAHINDRA & MAHINDRA LTD. INTEGRATED ANNUAL REPORT 2020-21 3. Impairment loss allowance in the financial services business (contd.) The key audit matter How the matter was addressed in our audit Under Ind AS 109, Financial Instruments , allowance for loan losses are determined using an expected credit loss (ECL) model. The estimation of impairment loss allowance on financial instruments involves significant judgement and estimates. The key areas where we identified greater levels of management judgement and therefore increased levels of audit focus are: • Data inputs - The application of ECL model requires several data inputs. This increases the risk that the data that has been used to derive assumptions in the model, which are used for ECL calculations, may not be complete and accurate. • Model estimations – Inherently judgmental models are used to estimate ECL which involves determining Exposures at Default (“EAD”), Probabilities of Default (“PD”) and Loss Given Default (“LGD”). The PD and the LGD are the key drivers of estimation complexity in the ECL and as a result are considered the most significant judgmental aspect in the modelling approach. • Economic scenarios – Ind AS 109 requires measurement of ECL on an unbiased forward-looking basis reflecting a range of future economic conditions. Significant management judgement is applied in determining the economic scenarios used and the probability weights applied to them especially when considering the current uncertain economic environment arising from COVID-19. • Qualitative adjustments/ management overlays – Adjustments to the model-driven ECL results as overlays are recorded by management to address known impairment model limitations or emerging trends as well as risks not captured by models. As at 31 March 2021, overlays represent approximately 21% of the ECL balances. These adjustments are inherently uncertain and significant management judgement is involved in estimating these amounts especially in relation to economic uncertainty as a result of COVID-19. The underlying forecasts and assumptions used in the estimates of impairment loss allowance are subject to uncertainties which are often outside the control of the reporting entities. The extent to which the COVID-19 pandemic will impact the current estimate of impairment loss allowances is dependent on future developments, which are highly uncertain at this point. Given the size of loan portfolio relative to the balance sheet and the impact of impairment allowance on the financial statements, we have considered this as a key audit matter. Management has also taken consideration of the Reserve Bank of India (RBI)’s expectation to bring down the net Non Performing Assets (NPA) ratio below 4% and recorded an additional provision of Rs. 1,320 crores on Stage 3 loans, which is over and above the model determined ECL provision/overlays. • Assessed the design and implementation of controls in respect of the impairment allowance process such as the timely recognition of impairment loss, the completeness and accuracy of reports used in the impairment allowance process and management review processes over the calculation of impairment allowance and the related disclosures on credit risk management; • Tested management’s controls over authorisation and calculation of post model adjustments and management overlays; • Evaluated whether the methodology applied is compliant with the requirements of the relevant accounting standards and confirmed that the calculations are performed in accordance with the approved methodology, including checking mathematical accuracy of the workings; • Sample testing over key inputs, data and assumptions impacting ECL calculations to assess the completeness, accuracy and relevance of data and reasonableness of periods considered, economic forecasts, weights, and model assumptions applied; • Test of details on post model adjustments, considering the size and complexity of management overlays with a focus on COVID-19 related overlays, in order to assess the reasonableness of the adjustments by challenging key assumptions, inspecting the calculation methodology and tracing a sample of the data used back to source data; • Testing the ‘Governance Framework’ over validation, implementation and model monitoring in line with the RBI guidance. Discussed with and read the relevant correspondences with the RBI with respect to the RBI’s expectation to bring the net NPA ratio below 4%; • Involved financial risk modelling specialists for evaluating the appropriateness of Ind AS 109 impairment methodologies and reasonableness of assumptions used (including management overlays) and the reasonableness of the impact assessment of the current economic environment due to COVID-19 on the impairment loss allowance determination. • Verified the mathematical accuracy of the workings required to bring down the net NPA ratio below 4%; and • Assessed whether the disclosures (including arising from the RBI expectation to bring down the net NPA ratio below 4%) on key judgements, assumptions and quantitative data with respect to impairment loss allowance in the consolidated financial statements are appropriate and sufficient. Other Information The Holding Company’s management and Board of Directors are responsible for the other information. The other information comprises the information included in the Holding Company’s annual report, but does not include the financial statements and our auditors’ report thereon. Our opinion on the consolidated financial statements does not cover the other information and we do not express any form of assurance conclusion thereon. In connection with our audit of the consolidated financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. If, based on the work we have performed and based on the work done/ audit report of other auditors, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard.