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Regulator pragmatism will help banks deploy capital

27 March 2020: Europe’s top financial regulators have stressed the importance of the flexible and pragmatic application of IFRS9 to cope with troubled loans during the COVID-19 pandemic, reports Chris Warmoll.

Both the European Banking Authority (EBA) and European Securities and Markets Authority (ESMA) issued guidance on Wednesday on how to apply the International Financial Reporting Standard 9 (IFRS 9) in a way that affords them a greater freedom of judgment in its application.

It follows warnings from banks that they face greater provisions as businesses they lent to become ever more stressed and struggle to repay their loans in the wake of the coronavirus outbreak.

In a statement the EU’s securities watchdog said: “In ESMA’s view, the principles-based nature of IFRS 9 includes sufficient flexibility to faithfully reflect the specific circumstances of the COVID-19 outbreak and the associated public policy measures.

“ESMA will continue monitoring issuers’ practices in relation to IFRS 9 and in particular as regards the application of judgement in the current context.”

The statements are intended to ease growing concerns that IFRS 9 might compel lenders to set aside funds against loan defaults that benefit from public guarantees or a payment moratorium.

Responding to the EBA’s measures, ICAEW’s Philippa Kelly, said: “A pragmatic approach from regulators will help enable banks to best deploy their capital to help individuals and businesses weather the challenges of COVID-19. The intention of Government support is such that triggering a ‘significant increase in credit risk’ would frustrate the purpose of the support as bank lending would be curtailed due to the capital impact of recognising larger expected losses. 

“Clarifying that use of support will not automatically mean a deterioration in asset quality is beneficial. The EBA’s statement of 25 March emphasises their view that banks need to consider their customers’ standing and creditworthiness in the long term,” continued Kelly.

“The EBA also points out the importance of customers understanding the implications of taking up any support measures. At a time when applicants are going to be stressed and looking for rapid action, banks must communicate clearly all aspects of what they are offering in an empathetic and straightforward way.”

The European financial regulators were also joined by the Committee of European Oversight Bodies (CEAOB).

“Whilst auditors have to comply fully with required standards, the Committee of European Audit Oversight Bodies (CEAOB) wishes to emphasise certain challenges that auditors are facing due to the unprecedented scale of the outbreak, which could have an adverse effect on audit quality,” it said in a statement.

These included problems obtaining appropriate audit evidence due to access, travel restrictions, staff sickness and time issues, resulting in potential reporting deadline delays.

Going concern was also flagged as potentially problematic due to uncertainty around worldwide economic forecasting and the impact of evaluating the management’s assessment of the entity’s ability to continue as going concern.

Reporting and communication were other areas likely to be impacted with auditors reminded that they could include a key audit matter in their report. 

The CEAOB went on to say that it “acknowledges the ESMA statement on the accounting implications of the current situation on the calculation of expected credit losses under IFRS 9 as well as the statement by ESMA on the recommended actions by financial market participants, in particular those about disclosure and financial reporting”.