The financial services industry has recently undergone a major change due to the introduction of IFRS 9 impairment requirements. This has come generally at increased costs due to either the redirection of internal resource or engagement of third parties to develop compliant models.
IFRS9 Expected Credit Losses (ECL) are commonly calculated as the sum of the marginal future expected losses in each period following the reporting date, using PD, LGD and EAD components. ECL can also be calculated directly from expected future cash flows. This could be an attractive option for many short-term lenders, especially for those that cannot leverage existing PD, LGD and EAD models, as it requires developing a single cash flow model.
A recent report has suggested that European MEPs want more scrutiny of accounting standards issued by the International Accounting Standards Board (IASB) with an emphasis less complex rules, in addition to calling for scrutiny of whether standards allow tax fraud as well as improved governance of the IFRS Foundation, which governs the IASB.
The FT covered a piece on a regulatory crackdown that it claims removes the key incentive for measuring risk – view the full article here https://next.ft.com/content/672e8d6a-1d63-11e6-b286-cddde55ca122 Here is our response - this certainly covers the impact for investment banks as rather than retail. What BCBS have announced is that they are potentially withdrawing IRB treatments for exposures against large corporates and other banks.
Traditionally, the relationship between collections and impairment is one way under IAS39. Collections activity can influence the severity of the loss and in the best case, can return accounts to order. This impacts the impairment line in two ways, the amount recovered and the direct cost of collecting it.
Regulations that aim to increase understanding of risks for management, investors and the general public are effective, self-reinforcing and are likely to change emergent behaviour. Market wide stress testing initiatives have been particularly powerful in this regard – by requiring banks to consider explicitly the worst scenarios and publish the outcomes, the market has been driven to protect and plan for those events.
Based on our experience, there are a number of aspects that are common to every IFRS 9 project – they include:The solution you thought you would arrive with at the start is not actually the solution you end up with IFRS 9 is a vastly complex challenge and whilst simplifications can be applied, they need to be relevant and justifiable for your organisation.
Another interesting consideration ahead of the impending accounting standard IFRS 9, is the effect this could have on valuation and pricing. Under IAS39 you only consider lifetime losses when the impairment event has already happened so you only hold a small amount of provision for your entire up to date book.
The changes needed to meet the new IFRS 9 requirements are substantial and will require significant thought and effort by individual organisations and their advisors to develop a compliant solution that is right for them. Some larger, more complex and systemically significant organisations have been working on this for a number of years and still don’t have all of the answers
In line with the impending changes to accounting rules via IFRS 9 Financial instruments standard in the EU, it’s been announced that the European Banking Authority (EBA) is launching an impact assessment of the standard on a sample of approximately 50 institutions across the EU.
It’s something many have deliberated on and the speculation continues. We think this rather depends on how consistently and robustly the impending changes are implemented across the industry.
Since the publication of the Final Standard in July 2014 and the previous release of the Exposure Draft, there has been a lot of thinking and analysis on what the requirements for IFRS 9 really mean and how practically to implement them in different organisations.