International Financial Reporting Standard 9 (IFRS 9) will soon replace International Accounting Standard 39 (IAS 39). The change will materially influence banks’ financial statements, with impairment calculations affected most. IFRS 9 will cover financial institutions across Europe, the Middle East, Asia, Africa, and Oceania.
IFRS 9 will align measurement of financial assets with the bank’s business model, contractual cash flow of instruments, and future economic scenarios. In addition, the IFRS 9 provision framework will make banks evaluate how economic and credit changes will alter their business models, portfolios, capital, and the provision levels under various scenarios.
Given the IFRS 9 requirements in terms of classification, measurement, and impairment calculation and reporting, banks should expect to be required to make some changes to the way they do business, allocate capital, and manage the quality of loans and provisions at origination. Banks will face modeling, data, reporting, and infrastructure challenges in terms of both:
- Reassessing the granularity (e.g., facility-level provisioning analysis) and/or credit loss impairment modeling approach (e.g., consistency regarding the definition of default between Basel and IFRS 9 models).
- Enhancing coordination across their finance, risk, and business units.
Effectively addressing these challenges will enable bank boards and senior management to make better-informed decisions, proactively manage provisions and effects on capital plans, make forward-looking strategic decisions for risk mitigation in the event of actual stressed conditions, and help in understanding the evolving nature of risk in the banking business. In the end, a thoughtful, repeatable, consistent capital planning and impairment analysis should lead to a more sound, lower-risk banking system with more efficient banks and better allocation of capital.
To help minimize the challenges faced by financial institutions when transitioning to IFRS 9, we conducted the Moody's Analytics 2015 IFRS 9 Survey to give practitioners a snapshot of the "current state" of the industry. Moody's Analytics has also included a series of comments on best practices and industry trends.
IFRS 9 will affect the business models, processes, analytics, data, and systems across several dimensions.
- Provision levels are expected to substantially increase under IFRS 9 versus IAS.
- Further equity issuances may be needed, with the potential for greater pro-cyclicality on lending and provisioning owing to IFRS 9. Capital levels and deal pricing will be affected by the expected provisions, but must be evaluated under different economic cycles and scenarios.
- Banks will have to estimate and book an upfront, forward-looking expected loss over the life of the financial facility and monitor for ongoing credit-quality deterioration.
- Rating and scoring systems may have to be updated, especially for those banks without Internal Ratings-Based (IRB) models.
- Banks will need to reclassify assets and reconcile them with IAS. They will also need to map products that can be categorized before the calculation (contractual cash flow test) or create a workflow to capture the purpose (business model test). An additional effort could be required to identify those products that can be considered out of scope (e.g., short-term cash facilities and/or covenant-like facilities).
- Institutions will have to align, compare, and reconcile metrics consistently (e.g., Basel vs. IFRS 9).
- Financial institutions will have to coordinate finance, credit, and risk resources for which current accounting systems are not equipped.
- The IFRS 9 provision model will make banks evaluate, at origination, how economic changes will affect their business models, capital plans, and provisioning levels.
- A methodology to calculate a forward-looking measurement will have to be developed and/or updated (e.g., transformation from TTC to PiT), while the cash flow valuation analysis must be scenario-driven.
- IFRS 9 will affect the existing documentation and hedge accounting frameworks.
- Systems will need to change significantly to calculate and record changes requested by IFRS 9 in a cost-effective, scalable way.
- Data requirements will increase to meet IFRS 9-related calculations and ongoing monitoring.
- Retrieval of old portfolio data will also be needed, especially for the transactions originated before the A-IRB models have been introduced.
- IFRS 9 impairment calculation requires higher volumes of data than IAS, which may substantially increase the performance and computational requirements of a credit-loss impairment calculation engine.
- Financial reporting and reconciliation will be needed to align with other regulatory requirements.
- IFRS 9 makes the provisioning exercise a cross-functional activity, with coordination needed across the risk, finance, accounting, and business functions.
IFRS 9 is the International Accounting Standards Board’s (IASB) response to the financial crisis, aimed at improving the accounting and reporting of financial assets and liabilities. IFRS 9 replaces IAS 39 with a unified standard. In July 2014, IASB finalized the impairment methodology for financial assets and commitments. The mandatory effective date for implementation is January 1, 2018; however, the standard is available for early adoption (e.g., via local endorsement procedures).
IFRS 9 introduces changes across three areas with profound implications for financial institutions:
- The classification and measurement of financial assets
- The introduction of a new expected-loss impairment framework
- The overhaul of hedge accounting models to better align the accounting treatment with risk management activities
Replacing IAS 39 with IFRS 9 will significantly impact banks’ financial statements, the greatest impact being the calculation of impairments:
- IAS 39 – A provision is made only when there is a realized impairment. This results in “too little, too late” provisions and does not reflect the underlying economics of the transaction.
- IFRS 9 – Aligns the measurement of financial assets with the bank’s business model, contractual cash flow characteristics of instruments, and future economic scenarios. Banks may have to take a “forward-looking provision” for the portion of the loan that is likely to default, as soon as it is originated.
IFRS 9 has also several common characteristics with the Financial Accounting Standards Board’s (FASB) Current Expected Credit Loss (CECL) model provisioning framework to be implemented in the US.
IFRS 9 will be required for financial institutions in Europe, the Middle East, Asia, Africa, and Oceania. Specifically:
- Companies listed on EU stock markets and EU banks must use IFRS reporting standards in preparing their consolidated financial statements.
Europe: More than 230 banks (banks of significant importance)
- Asia, Americas (excluding the US), Oceania, and Africa will be implementing IFRS either through a local-endorsement process or convergence of the respective country-specific standard.
Asia and the Middle East: More than 370 banks (banks of significant importance)
Institutions in the US will not be subject to IFRS 9 (GAAP is mandatory for those institutions). However, FASB will introduce a similar analytical framework (CECL) if the current proposal is approved under the proposed form without major modifications.
With all eyes on IFRS 9, Moody’s Analytics carried out our first IFRS 9 survey to help practitioners better understand how their peers are preparing for the implementation. Overall, banks that participated in the survey are accelerating their planning, budgeting processes, and road-mapping activities for full-scale implementation projects, given the finalization of the IFRS 9 standard.
The survey consolidates the views of 28 banks regarding how they are approaching the challenges that IFRS 9 poses. Banks answered 22 questions across five main areas:
- Business uses
- We gathered our survey results from a significant cross section of institutions of all sizes, proof that IFRS 9 implementation is on the agenda, regardless of the size of the bank.
- More than 60% of the institutions have operations in the EMEA and APAC regions where IFRS 9 will be mandatory. Institutions in the US will not be subject to IFRS 9 (GAAP is mandatory for those banks).
- More than 72% of the respondents are from the risk and finance divisions at banks who will also be the major users of IFRS 9 (from an impairment-calculation and financial reporting perspective, respectively).
- Finance is the main stakeholder given the financial reporting implications of IFRS 9. However, the risk division closely follows finance given its role in the credit-impairment calculation.
- More than 82% of banks surveyed have a formal roadmap in place and plan to carry out a parallel run ahead of the implementation deadline.
- More than 85% of banks surveyed plan to have an operational IFRS 9 solution by 2017 (one year before the mandatory date to be IFRS 9 compliant).
- More than 40% of the respondents are planning to integrate IFRS 9 requirements in the Basel infrastructure.
- More than 43% of the respondents have allocated a budget of more than $2 million to meet the IFRS 9 requirements and improve their infrastructure and analytics.
- Gathering granular data and developing PD and LGD IFRS 9-compliant models are the major challenges to designing and implementing an IFRS 9 solution.
- More than 40% of the respondents plan to add the credit impairment and expected loss calculation engine to their Basel risk systems.
- More than 82% of the respondents plan to leverage their ALM systems to compute amortizing balances.
- More than 63% of the respondents plan to leverage their Basel IRB models for the credit-loss impairment calculation.
- More than 50% of the respondents plan to run facility-level calculations for the retail portfolio; more than 85% of the respondents are planning to run this level of granularity for the wholesale portfolio.
- Improved timely provisioning planning and better origination practices and capital planning are the major IFRS 9 benefits for the business.
- More than 68% of the respondents plan to run monthly calculations aligned with the frequency for Basel-related calculations (e.g., RWAs).
- More than 90% of the respondents are planning to integrate IFRS 9 scenario analysis into capital planning, stress testing, and origination activities.
Managing Director, Data Intelligence
Mr. Gea-Carrasco works with financial institutions to address their technology and enterprise risk management needs. Previously, Mr. Gea-Carrasco held leadership positions at various institutions and global banks.
Focuses on helping financial institutions improve their data management practices and capabilities for enhanced risk management, business value, and regulatory compliance.
Previous ArticleRegulatory Big Data: Regulator Goals and Global Initiatives
Next ArticleWhat if PPNR Research Proves Fruitless?
In this article, we examine the role of new and emerging technologies in the rapidly evolving financial technology space.
July 2017 WebPage Keith Berry, Cayetano Gea-Carrasco
This article provides an overview of the new standard and analyzes the major challenges financial institutions will face in ensuring IFRS 9 compliance.
This article discusses the importance of effective resolution plans, given their impact throughout a business.
November 2014 WebPage Cayetano Gea-Carrasco
Implementing an Effective Stress Testing Program for Risk Management Governance and Regulatory Compliance
This article discusses the regulatory view on governance for stress testing in the US, UK, and euro zone, as well as aspects of governance best practice and implementing an effective stress testing program.
November 2014 WebPage Cayetano Gea-Carrasco
On October 26th, the European Central Bank (ECB) published the results of the Comprehensive Assessment (CA – AQR and Stress Test). This article discusses the results, next steps such as the timeline and capital plan to meet the capital shortfall, other potential areas of enhancement at banks, and future expectations.
October 2014 Pdf Cayetano Gea-Carrasco
Preparing for the 2014 EBA Stress Test - Best Practices for Regulatory Stress Testing & Capital Modeling
This Moody's Analytics and PRMIA webinar-on-demand provides an overview of EU stress testing regulatory requirements and the Moody's Analytics capabilities and solutions that will help you meet them.
April 2014 WebPage Cayetano Gea-Carrasco, Stephen Clarke, Andy Condurache
This article discusses the importance of managing and measuring liquidity risk, regulatory guidelines and implications, and how an effective enterprise-wide stress testing program requires and integrates liquidity risk.
November 2013 WebPage Cayetano Gea-Carrasco, David Little
Forecasting revenue, expense, portfolio losses, and capital ratios plays an essential part in a stress testing framework. We examine the current state of stress testing and how institutions can prepare for upcoming regulatory requirements, such as the AQR.
September 2013 WebPage Cayetano Gea-Carrasco, Isabel Gomez Vidal
This article outlines the steps to perform reverse stress testing, which explores tail risks and reveals hidden vulnerabilities and scenarios not reflected through traditional stress testing analysis.