The IASB issued its final version of IFRS 9 Financial Instruments in July 2014, but for banks this is not the end of the story. Hannah King from Accounting Consulting Services tells us about recent developments.
IFRS 9 introduces a new expected credit loss (ECL) approach to impairment provisioning for financial instruments: a radical move away from the current incurred loss model in IAS 39. Following the issue of IFRS 9, two bodies - the Basel Committee on Banking Supervision (the Committee) and the Enhanced Disclosure Task Force (EDTF) - have recently published guidance in respect of the ECL requirements in IFRS 9.
Both publications are aimed at large internationally active banks, but other large and more sophisticated banks may also find the additional guidance relevant.
Basel Committee Guidance on accounting for ECL for banks
In December 2015, the Committee issued its ‘Guidance on credit risk and accounting for expected credit losses’. This sets out supervisory guidance on sound credit risk practices associated with the implementation and ongoing application of ECL accounting frameworks, such as that introduced in IFRS 9.
Notably, the Committee expects a disciplined, high-quality approach to assessing and measuring ECL by banks.
The Guidance discusses some of the areas requiring significant judgement involved in implementing the ECL requirements, as well as highlighting the need for good governance, controls, processes and disclosure.
Forward looking information
Amongst other things, the Committee emphasises the importance of including a wide range of relevant, reasonable and supportable forward-looking information, including macroeconomic data, in a bank’s accounting measure of ECL. In particular, banks should not ignore future events simply because they have a low probability of occurring or on the grounds of increased cost or subjectivity. This has particular relevance for one-off uncertain events, for example, a future vote on the UK leaving the European Union. However, the Committee does acknowledge that in certain exceptional circumstances, information about a future event may not be reasonable and supportable, in which case it should be excluded from the determination of ECL.
‘Low credit risk’ exemption
In the Committee’s view, the use of the practical expedients in IFRS 9 should be limited for internationally active banks. This limitation includes restricting the use of the ‘low credit risk’ exemption for lending exposures (although there still may be some scope to use this exemption for securities).
Using the exemption in IFRS 9 negates the need to assess whether there has been a significant increase in credit risk since initial recognition for those financial instruments that are of low credit risk (for example, investment grade). Not being able to take advantage of the exemption could involve considerable more work and analysis.
EDTF IFRS 9 Impairment disclosure recommendations
In November 2015, the EDTF published a report ‘Impact of Expected Credit Loss Approaches on Bank Risk Disclosures’. This recommends disclosures in banks’ annual reports to help the market understand an ECL approach to impairment, such as that in IFRS 9.
Transition period from now to adoption
IFRS 9 comes into effect from 2018. The EDTF highlights that disclosures are needed in the transition period leading up to adoption of IFRS 9, starting with 31 December 2015 annual reports. As summarised in the diagram below, the EDTF recommends a gradual, phased approach to disclosures during this transition period. The EDTF suggests that initially the focus should be on qualitative disclosures. Quantitative information about the impact of IFRS 9 should follow, but at the latest in 2017 annual reports.
Ongoing ‘permanent’ disclosures
The EDTF also recommends disclosures that will apply on a permanent basis once IFRS 9 has been adopted and which go considerably further than those required by accounting standards. For example, the EDTF recommends that banks offer sensitivity disclosures. These would show the key drivers of change in credit losses when they are meaningful and relevant to understanding material changes.
Banks, in particular internally active banks and other large more sophisticated banks, should consider the implications of the Basel Guidance and the EDTF’s disclosure recommendations. Banks should determine the extent to which the additional guidance applies and how they plan to incorporate it into their IFRS 9 implementation processes.
In doing so, banks will need to consider the views of their local regulator.
As well as the ongoing disclosure requirements post IFRS 9 implementation, banks should consider the transition disclosures needed now and up to the first period of adoption of IFRS 9.
Indicative timeline for implementing the EDTF disclosure recommendations in the transition period:
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