What IFRS 9 Financial Instruments means for local banks

14Feb 2017
The Guardian Reporter
The Guardian
What IFRS 9 Financial Instruments means for local banks

IFRS 9 is an International Financial Reporting Standard (IFRS) promulgated by the International Accounting Standards Board (IASB).

IFRS 9 is an International Financial Reporting Standard (IFRS) promulgated by the International Accounting Standards Board (IASB). It addresses the accounting for financial instruments and contains three main topics: classification and measurement of financial instruments, impairment of financial assets and hedge accounting. It will replace the earlier IFRS for financial instruments, IAS 39, when it becomes effective in 2018. A KPMG Partner, Vincent Onjala spoke to Smart Money Reporter on the subject, excerpts:

Q: What is the main emphasis of IFRS 9 for banks?

IFRS 9 Financial Instruments is effective from 1 January 2018 and replaces IAS 39 Financial Instruments and focuses on: Recognition and Measurement. The main focus of this new standard is to establish principles for financial reporting of financial assets and financial liabilities that will present relevant and useful information to the users of financial statements of various entities. Financial assets include items such as loans and advances, equities/shares, treasury bills and bonds, commercial papers, derivatives among many others.

Q: What are the implications of the new requirements to the banks?

The new requirements will have significant impact on banks because they deal with many financial assets and financial liabilities. For example, impairment on loans and advances is expected to increase by up to 50 percent. This is due to change in methodology for determining impairment.

In the new standard, banks will have to use the Expected Credit Loss model as opposed to the current approach under IAS 39 that follows an Incurred Loss Model approach where impairment is booked after a loss event has happened.

Under IAS 39 framework, banks wait for a customer to default on loan repayment or show signs of credit weaknesses before booking impairment for loans and advances. Under the Expected Credit Loss model in the new standard, banks are required to apply the Expected Credit Loss model which calls for banks to determine and recognize impairment upfront when originating loans and advances. This is a departure from the old Incurred Loss model.

Q: How will banks do this?

In determining the expected credit loss, banks have to incorporate reasonable and supportable information that is reasonably available at the reporting date without undue cost or effort. This information includes information about past events, current conditions and forecasts of future economic conditions.

IFRS 9 does provide guidance that the information used in determining impairment levels shall be specific to the borrower, general economic conditions and an assessment of both the current as well as forecast direction of conditions at the reporting date. Possible sources of data include internal historical credit loss experience, internal ratings, credit loss experience of other entities and external ratings, reports and statistics.

Q: So what should banks do precisely before IFRS 9 becomes effective?
Banks have to think about the impact on capital and plan for capital injection depending on how each of the banks gets impacted. Key will be for banks to relook at how they operate and revamp their internal processes especially around credit origination to minimize huge exposure from 2018 onwards.

Q: What challenges do you anticipate banks will encounter while implementing this new standard?

Banks will be faced with several challenges including the quality of data that is required to develop models that will help them comply with the new requirements. Also, there is shortage of skills around this area and banks will have to work with external consultants to support them with implementation of these new requirements.

Bank may have to invest in good IT systems that can handle the data requirements for compliance with IFRS 9. In addition, some of the inputs such as level of deterioration of credit risk leading to significant increase in credit risk are judgemental.

Q: How do you see Tanzania banks faring in the adoption of these requirements compared to other markets in Africa?

Most banks are still in the early stages of carrying out readiness assessment tests together with quantitative impact survey. I would expect that multinational banks are getting support from their parent companies as they prepare for implementation of these new requirements.

It is important for local banks to engage professionals with the requisite skills and experience to support them in IFRS 9 implementation journey. It will be good if banks can carry out a parallel run of IFRS 9 and IAS 39 models and plan for the impact early enough to avoid surprises in 2018.

Q: How is this going to be different from the current provisioning policy as provided by Bank of Tanzania?
The two methodologies are very different. Bank of Tanzania follows a time based approach and does not recognise collaterals. The prudential guidelines do provide for how to account for the difference between IFRS and Bank of Tanzania levels of provisions.

Under the new requirements in IFRS 9, the level of impairment will be driven by many factors including the past events, current conditions and forecasts of future economic conditions.

Majority of banks surveyed around the world expect their expected loss under the new requirements to be higher than the current regulatory provisioning levels. The impact on capital will be dependent on regulatory rules regarding expected loss treatment.

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