July 17, 2017

ESRB published a report on the financial stability implications of IFRS 9, the International Financial Reporting Standard for the classification and measurement of financial instruments. The report analyzes two main aspects of IFRS 9 from a macro-prudential angle and with a focus on banks: the new approach to the classification and measurement of financial assets and the new expected credit loss (ECL) approach for measuring impairment allowances.

The report also analyzes the cyclical implications of the ECL approach in IFRS 9 for aspects that are potentially relevant to financial stability, including loan pricing and the creation of incentives for shortening loan maturities or modifying other aspects of lending behavior. The last section of the report focuses on the five primary areas identified as deserving attention from the perspective of financial stability, offering an assessment and some policy considerations on each of them. These areas are usage of fair value accounting, modeling risk, lending behavior, procyclicality, and use of standardized approach by less sophisticated banks. The report reflects a long debate on the use of fair value or historical cost for the measurement of financial assets and the suitability of these methods for different bank assets. The report concludes that the classification of financial assets under IFRS 9 will, in principle, be clearer and sounder than under its predecessor and should not generally lead to a significant increase in the use of fair value by EU banks, at least at the aggregate level. It identifies three areas in which there are significant changes relative to IAS 39 and which, for specific banks or periods of time, could entail relevant differences:

First, debt instruments, including embedded derivatives will no longer qualify to have their pure debt component separated and thus measured at amortized cost.

Second, except for dividend income, none of the gains or losses from equity instruments measured at fair value through other comprehensive income will be reported in profit or loss.

Third, highly liquid assets eligible for inclusion in the regulatory liquidity buffer but which, on the basis of their management during normal times, belong to a hold-to-collect business model may be measured at amortized cost, raising concerns about the emergence of unrealized fair value gains or losses if they need to be sold in times of acute stress.

 

According to the assessment in the report, the aggregate quantitative importance of the assets affected by the first two changes is very small, while the importance of the third will depend on business model choices that are hard to anticipate on an ex ante basis. This ESRB report has been prepared following a request by the European Parliament to consider the IMF financial stability implications of IFRS 9. The European Union endorsed IFRS 9 in November 2016 for mandatory application from January 01, 2018 onward.

 

Related Link: ESRB Report (PDF)

Keywords: Europe, Accounting, Banking, Reporting, IFRS 9, ECL, Financial Stability, ESRB


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