The IFRS 9 required movement from an incurred loss to an Expected Credit Loss (ECL) approach will for most banks increase the overall credit loss provisioning levels and at the same time reduce Core Equity Tier 1 (CET1) capital ratios. The profit and loss volatility will likely increase after the implementation of IFRS 9. The implementation of an Expected Credit Loss approach might even impact product pricing for lending products.
IFRS 9 - Financial Instruments Accounting - replaces IAS 39 containing three key main parts: (1) Classification and Measurement, (2) Impairment and (3) Hedge Accounting. The 6th Global Deloitte IFRS Banking Survey focuses on impairment. For the financial services industry the change from an incurred loss model to an expected credit loss model is for most banks very significant. Lending and the related loan loss provisioning represents a core banking activity for most banks and the expected loss approach will require loan loss provisions on day 1 and may even have implications on the pricing of loans.
The IFRS 9 impairment requirement distinguishes between three different stages applicable to ‘Amortised Cost’ and ‘Fair Value through Other Comprehensive Income (FVtOCI)’ financial assets. At initial recognition (stage 1) a 12-month expected credit loss needs to be provided for. Stage 2 requires a life-time expected credit loss provision where a significant increase in credit risk has occurred. While stage 1 and 2 provisions are done on a portfolio basis stage 3 provisions are individually identified covering also life-time expected losses. The IFRS 9 expected loss concept was primarily developed to address the perceived ‘too little too late’ loan loss provisioning under the old IAS 39 incurred loss model which has been criticised by constituents in the aftermath of the financial crisis. It, however, appears that accounting standard setters are requiring an expected credit loss accounting approach at a time when regulators start reducing modelling options and are putting again more reliance on standardised, simple methods.
The majority of banks responding to the survey expect the impairment provisions to increase by up to 25% across asset classes. 70% of the banks expect a reduction of their Core Equity Tier 1 (CET1) capital ratio of up to 50 bps due to IFRS 9. We recommend early communication of the potential implications to stakeholders avoiding surprises. Further, most banks expect with the implementation of IFRS 9 a significant increase in volatility of their profit and loss (p&l) which will need to be explained to stakeholders. Interestingly, most price makers expect that moving to an Expected Credit Loss model will have an impact on product pricing, while most price takers think that this is unlikely to have an impact on product pricing. For Swiss banks the new IFRS 9 impairment requirements may have lower implications compared to certain other countries in terms of additional provisioning and reduction in capital due to the very low loan losses in past years, however, changes of the economic environment can happen quickly resulting in higher expected credit losses..
The IFRS 9 implementation, mandatorily required as of 1.1.2018, poses a number of challenges for financial institutions like for example the inclusion of forward looking macroeconomic information, data quality & availability and the determination of significant increase in credit risk. In general, approximately half of the participants are unsure of the answers to many key modelling design questions and interpretations. 39% of the larger banks (respondents over € 100bn of gross lending) expect implementation cost of € 25 million – € 100 million.
The IFRS 9 Expected Loss requirement, the new Lease accounting standard (IFRS 16) together with other upcoming regulatory changes further add to the continued capital constraints that banks are facing.