Countdown to IFRS 9
How should the banks be preparing for IFRS 9? Zsuzsanna Schiff and Philippa Kelly take a look
While banks get ready for IFRS 9, the Enhanced Disclosure Task Force (EDTF) has been asked to assess what information the market might need now – and in the run-up to its application – in order to understand what the numbers mean, and to avoid panic or overreaction at impairment numbers that will inevitably be much larger than they previously were.
Following the financial crisis and consistent with a widely shared view that the impairment methodologies should incorporate a broader range of credit information, the International Accounting Standards Board introduced a new credit impairment approach in IFRS 9: Financial Instruments issued in 2014 to replace IAS 39 Financial Instruments: Recognition and Measurement. The US Financial Accounting Standards Board (FASB) has substantially completed re-deliberations on its credit losses standard with issuance of a new standard expected in the first quarter of 2016. Although there are some key differences (namely in the timing of recognition of lifetimes losses), both are based on the concept of measurement of expected credit losses (ECL).
Implementing the new approach
The complex new standard includes extensive basis for conclusions, but not necessarily practical guidance. To help banks implement the standard in a high quality and consistent way, the Basel Committee on Banking Supervision has produced its own guidance on accounting for expected credit losses. Building on the success of its earlier work, the Financial Stability Board requested the EDTF to consider disclosures that may be useful to help the market understand the upcoming changes as a result of using ECL approaches (whether under US GAAP or IFRS) and to promote consistency and comparability of what is presented.
The EDTF focuses on internationally active banks, where the importance of high-quality disclosures particularly increases when using ECL models. This accounting model will include a greater degree of management judgement than before and will employ model-based calculations that are inherently complex.
While banks may be comfortable with the models they employ for these calculations and users of Pillar 3 information have an understanding regulatory Expected Loss (EL) for capital adequacy purposes, these will not be the same as IFRS expected losses.
Time to reassess
In 2015 the EDTF reconvened at the request of the FASB to assess whether its original principles and recommendations were still valid. The consensus was a need for further guidance around disclosures during the transition to IFRS 9. This is especially important considering the effect of ECL on banks financial performance and regulatory capital requirements. The recommendation is that banks explain:
- How their IFRS 9 implementation project is being run;
- How the standard will be interpreted and applied;
- What are the expected effects.
This will require collaboration between departments of banks. Credit risk, finance and IT need to work together to capture and report the relevant data. Disclosure to aid understanding of the implementation timeline, the bank’s interpretation of IFRS 9 terms (which may well differ greatly between banks and geographies) and the project’s governance will be valued by all stakeholders.
The focus isn’t solely on annual reports; the EDTF believes that certain risk disclosures in relation to ECL accounting should be made more frequently. The report makes specific recommendations in relation to timing of transition disclosures (see table below). These will need to be assessed individually by banks to ensure they have the appropriate level of detail of quantitative disclosures for the stage of the implementation.
Don't go all at once
For many banks the ECL approach is expected to increase the credit loss allowances on transition (the Deloitte Global IFRS Survey 2015 suggests by up to 50%)compared with the existing approach and users will want to understand the specific reasons for such changes. It will be important for banks to focus on material aspects, particularly the bank’s most significant portfolios and the factors and risks that cause the greatest variability in ECL measurement.
The EDTF also emphasised that given the extensive changes, it would be easy to overwhelm users with new information. In order not to unnerve them, a gradual and phased approach during the transition period would be most helpful and result in clearer insights into the likely impacts of the new standard.
Qualitative disclosure also has a role to play; describing the key concepts relating to the application of the ECL approach and how banks interpret and apply these will help users understand and appreciate the process more fully. Key elements include:
- The investment of time and resource needed to obtain the necessary data and the impact.
- How they have, or have a plan, to develop and enhance governance over the recognition and measurement of credit losses.
How they will develop their capability to make informed judgements about the use of forward-looking information. This task is challenging for banks. Given the continuing uncertainties around the endorsement of IFRS 9, banks need to consider how they apply recommendations. If they haven’t yet started to consider these challenges, the time is now.