BoE Paper Examines Impact of IFRS 9 on Funding Cost of Banks in Europe

IFRS 9, which replaces the incurred loss model of IAS 39 with a forward-looking expected loss model, is likely to result in an increase in the credit loss charges for banks, reducing after-tax profits and, hence, retained earnings, which are the main source of equity capital of banks. Thus, to maintain their capital ratios, banks may choose to hold higher levels of equity capital under IFRS 9. To estimate the impact of this IFRS 9-induced potential increase in equity capital on the cost of funding of banks, the study uses a modified version of the capital asset pricing model, or CAPM, to estimate the impact of this potential increase in capital levels on the cost of funding of banks in the UK, Germany, France, Italy, Spain, and Switzerland. 

The study shows that the implementation of IFRS 9 may slightly increase the funding cost of banks in the covered European countries, except France. Whether this impact can be viewed as an estimate of the longer-term impact of IFRS 9 depend on two elements, which are out of the scope of the analysis. The authors did not investigate whether the impact of IFRS 9 on the level of equity capital would be stable across different stages of the credit cycle. Likewise, the authors did not account for the potential positive effects of the early recognition of losses under IFRS 9 on asset quality transparency. An increase in this transparency might reduce (or increase) the cost of equity and debt for banks at different levels of leverage. In this case, the estimates would have overstated the impact of IFRS 9. Nevertheless, the analysis provides important insights about the potential implications of IFRS 9 on the cost of funding of banks. It also represents a good start for similar analyses in the future when IFRS 9 becomes more established.

Related Link: Working Paper

Keywords: Europe, UK, Banking, IFRS 9, Expected Credit Loss, IAS 39, Research, Financial Instruments, Regulatory Capital, Credit Risk, BoE