March 18, 2019

ESRB published a report that examines the concerns about procyclicality from the expected credit loss (ECL) model in IFRS 9, including the possible sources of procyclicality and its relevance from a financial stability perspective. The report also incorporates the recent information on the implementation of IFRS 9 by EU banks.

Given the limited experience with IFRS 9 to date, this report focuses on describing the aspects of the ECL model under IFRS 9 that could potentially contribute to procyclical bank behavior, along with the conditions under which such behavior would be more likely to arise. The report is focused on the impact at the onset of a downturn because it is a crucial time for the exacerbation of the depth and duration of a financial crisis. The report concludes that a substantial degree of uncertainty exists about the cyclical behavior of the ECL model in IFRS 9 and its impact on bank behavior. Stress tests and targeted and harmonized disclosures are effective tools to improve the understanding of this cyclical behavior. So far, experience of IFRS 9 is limited but points to the following three factors that are important in shaping the cyclical behavior of ECL approach in IFRS 9 and, therefore, may warrant closer monitoring and review going forward:

  • The principles-based nature of IFRS 9, with particular reference to the conditions and criteria that trigger the transfer of exposures from stage 1 (12 month expectation) to stage 2 (lifetime expectation) and further into stage 3, which, in turn, could facilitate a delay in loss recognition.
  • The ability of, and incentives for, banks to promptly incorporate into their ECL models all new information available on the expected trend of the economic cycle and to recognize losses in a timely manner under IFRS 9 (if recognition of credit losses is delayed because of inadequate modeling or improper incentives).
  • The use of point-in-time (PIT) estimates for expected credit losses should generate more volatile outcomes than through-the-cycle estimates, although that volatility should not be judged as negative per se and becomes less relevant if a bank has anticipated the downturn.

The report also concludes that the policy analysis should focus on how the requirements of IFRS 9 are being applied and whether banks have appropriate incentives to recognize credit losses in a timely manner. As IFRS 9 has only been applied since January 01 2018 and in a period of benign macroeconomic conditions, it is still too early to say whether IFRS 9 poses a real risk to financial stability and, therefore, requires prompt regulatory intervention. However, early evidence points to issues that regulators and supervisors may want to monitor closely going forward. These issues, which relate to the quality of foresight in banks’ ECL models, concern lack of information (for example, due to insufficient data or inherent behavioral biases to overweight more recent conditions or not consider tail events) and perverse incentives (that is, management incentives to avoid excessive volatility or adverse market perceptions rather than to build sufficient foresight into ECL estimates). The development of best practices or enhanced guidelines could make a positive contribution to ensuring that the financial stability benefits of IFRS 9 are reaped.

 

Related Link: Report (PDF)

 

Keywords: Europe, EU, Accounting, Banking, Procyclicality, ECL, IFRS 9, Credit Risk, Financial Stability, ESRB

Related Articles
News

US Agencies Adopt Rule to Exclude Community Banks from Volcker Rule

US Agencies (CFTC, FDIC, FED, OCC, and SEC) adopted a final rule to exclude community banks from the Volcker Rule, in line with amendments to certain sections of the Economic Growth, Regulatory Relief, and Consumer Protection (EGRRCP) Act.

July 22, 2019 WebPage Regulatory News
News

US Agencies Adopt Amendments to Simplify Regulatory Capital Rules

US Agencies (FDIC, FED, and OCC) adopted a final rule that reduces regulatory burden by simplifying several requirements in the regulatory capital rules for banks.

July 22, 2019 WebPage Regulatory News
News

IA of Hong Kong Delegates Inspection and Investigation Powers to HKMA

HKMA and IA of Hong Kong jointly issued a statement announcing the delegation of the inspection and investigation powers of IA to HKMA, pursuant to the statutory regulatory regime for insurance intermediaries under the Insurance Ordinance.

July 19, 2019 WebPage Regulatory News
News

FSB Extends Implementation Timeline for Policy Recommendations on SFTs

FSB announced adjustments to the implementation timelines for its recommendations on securities financing transactions (SFTs), specifically those related to the minimum haircut standards for non-centrally cleared SFTs.

July 19, 2019 WebPage Regulatory News
News

EBA Single Rulebook Q&A: Third Update for July 2019

EBA published answers to six questions under the Single Rulebook question and answer (Q&A) tool this week.

July 19, 2019 WebPage Regulatory News
News

EBA Report Assesses Regulatory Framework for Fintech Activities

EBA published the findings of its analysis on the regulatory framework applicable to fintech firms when accessing the market.

July 18, 2019 WebPage Regulatory News
News

OSFI Revises Capital Requirements for Operational Risk for Banks

OSFI is revising its capital requirements for operational risk, in line with the final Basel III revisions published by BCBS in December 2017.

July 18, 2019 WebPage Regulatory News
News

OSFI Consults on Revised Principles for Management of Liquidity Risk

OSFI proposed revisions to Guideline B-6 on the principles for the management of liquidity risk.

July 18, 2019 WebPage Regulatory News
News

ESMA Guidance on Disclosures for Credit Rating Sustainability Issues

ESMA published the technical advice on sustainability considerations in the credit rating market, along with the final guidelines on disclosure requirements applicable to credit ratings.

July 18, 2019 WebPage Regulatory News
News

FASB Issues Q&A on Estimation of Expected Credit Losses by Firms

FASB issued a second question-and-answer (Q&A) document that addresses more than a dozen frequently asked questions related to the Accounting Standards Update No. 2016-13 titled “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.”

July 17, 2019 WebPage Regulatory News
RESULTS 1 - 10 OF 3482