IFRS 9 to redefine risk recognition and absorption by banks
Dubai: Ahead of the introduction of International Financial Reporting Standards 9 (IFRS 9), a game-changer for banks across the world, UAE lenders need to prepare themselves to change the processes of reporting credit impairments, according industry experts.
The new regulation strongly affects the way credit losses are recognised in the balance sheet and profit and loss (P&L) statement. While impairments are currently based on “incurred losses”, IFRS 9 introduces an approach based on future expectations, namely expected losses (EL).
The main impact on banks is the need to recognise expected losses for all financial products, and at individual and grouped-asset levels. Banks will have to update their calculation at each reporting date to reflect changes in the credit quality of their assets. This will significantly increase the number and frequency of impairment quantifications that must be undertaken and the amount of data that must be processed for such purpose.
“IFRS 9 is a change that will significantly impact banks across the globe, as well as here in the UAE. In fact, the biggest accounting development for banks today is likely to be IFRS 9, as it will significantly impact balance sheets, accounting systems and processes,” said Yousuf Hassan, Partner, Risk Consulting at KPMG.
The new standard on risk recognition revises guidance on the classification of financial assets, and supplements the new hedge accounting principles published in 2013.
Guidance on impairment — that is, provisions for loan losses — are significantly different from current practice.
IFRS 9 will require recognition of losses by provisions to cover both already-incurred losses and some future expected losses.
If a bank provides a home loan, any number of events could result in a non-performing loan, such as the customer losing his job or suffering a serious injury.
“Under the current incurred credit loss model, the bank provides for a loan loss when such an event occurs. However, under the expected credit loss model, the bank is expected to anticipate that such an event could occur and therefore provide for losses earlier than previously,” said Hassan.
Adopting the new principles will require a lot of time, effort and money. The new standard requires banks to provide for expected credit losses over the lifetime of the loan on the date the loan is first recognised, based on the level of default expected over the next 12 months.
Where credit risk is assumed to significantly increase, loan-loss provisioning must be recognised based on the level of defaults expected over the expected life of the loan. This should lead to higher provisions, more complexity and deeper risk management involvement.
IFRS 9 is going to be a genuine paradigm shift for banks, not just in the UAE but worldwide. This is not an issue that affects only the finance or risk functions. The ripple effect of IFRS 9 will be felt across the organisation. Higher provisioning will force banks to review their capital requirements. Product mixes and business models will also need to be evaluated.
With a significant surge in provisions and its impact on profit and loss account expected, it will also be a big challenge for banks to plan ahead. Banks will need to factor this into their capital planning.
“We see only limited possibilities to cushion profit and loss from the worsening asset quality, given the implementation of IFRS 9 by 2019, which forces the bank to provision on expected losses, rather than incurred losses,” Jaap Meijer, head of Research at Arqaam Capital .
On the operational side, systems, processes and other infrastructure will need to change.
“Although the standard is applicable to accounting periods beginning on or after January 1, 2018, the changes are so pervasive and far reaching that, institutions should start acting now to comply with their requirements. Many, if not most, banks will require all of the time left to prepare for the expected credit loss requirements,” said Hassan.