Wolters Kluwer Examines the Impact of IFRS 9 on Regulatory Provisions

As the effective date of International Financial Reporting Standard (IFRS) 9 draws closer, it is not only banks that are busy making adjustments. The Basel Committee on Banking Supervision (BCBS) itself is currently conducting a consultation exercise on reconciling its framework with IFRS 9, particularly in terms of the treatment of provisions. While the push for a degree of consistency is to be welcomed, it is also likely to increase the pressure on banks — particularly smaller retail institutions — bracing for the IFRS 9 deadline of January 2018. That’s according to a new paper from integrated finance, risk and reporting technology vendor Wolters Kluwer, that argues the time is right to adopt new IT solutions to meet the impending requirements.

The BCBS consultation is a consequence of the more forward-looking approaches to risk assessment embedded in IFRS 9 and the US Financial Accounting Standards Board’s Current Expected Credit Loss (CECL) standard, due to take effect two years later. By basing provisioning requirements on expected credit losses (ECL) — rather than recognizing losses when they are incurred — these standards aim to strengthen bank credit risk management. As a result, however, banks will need to deploy new technology systems capable of handling the exacting new requirements.

And, due to the fundamental changes they will introduce to provisioning, these standards will have significant implications for regulatory capital provisions under the BCBS framework. In particular, these accounting models do not distinguish between the specific provisions (SP) and general provisions (GP) defined in the Basel standardized approach (SA) to credit risk. This is the approach typically adopted by smaller banks, while larger institutions tend to employ internal ratings-based (IRB) approaches that reference their own risk parameters, Wolters Kluwer experts note.

In this sense, larger banks have a ‘head start’ when it comes to absorbing IFRS 9-related provisions impact, as IRB approaches are already based on expected losses, the vendor notes. Smaller institutions, by contrast, are used to incurred loss models and depend to extent on the SP/GP distinction, since credit exposures are risk-weighted net SP and gross of GP, and a certain amount of GP can be included in Tier 2 capital. Under IFRS 9 they will also have to distinguish between relatively ‘safe’ Stage 1 assets (for which provisions are based on 12-month ECL) and more risky Stage 2 (for which provisions must be based on lifetime ECL) — not always a simple matter as the boundary between the two is relatively subjective.

“The ECL regime thus has the potential to significantly affect institutions’ capital ratios by forcing them to recognize impairments earlier and to set aside more provisions,” says Piet Mandeville, vice president of Financial Risk for Asia Pacific, at Wolters Kluwer. “This is especially true for smaller banks pursuing growth strategies based on consumer lending products (e.g. credit cards) in fast-developing markets like Southeast Asia, as the default rates on these products tend to be higher and their credit deterioration can be difficult to define.”

Notably, however, and based on Wolters Kluwer’s own recent research, it is clear many IFRS 9 implementations are already being delayed. This is backed up by a European Banking Association (EBA) study showing around half of institutions are still in the design stage — a ratio that is likely even higher for smaller banks using SA. This means the duration of the vital ‘parallel runs,’ in which banks simultaneously apply existing and IFRS 9 provisions approaches to analyze the impact on capital structure and business strategy, are likely to be squeezed even further.

“The BCBS exercise again highlights the period of uncertainty around capital measurement that IFRS 9 is set to usher in,” Mandeville adds. “This makes it more vital than ever that institutions adopt a phased, standardized approach to implementation, supported by technological solutions capable of running various models or scenarios simultaneously, and of ensuring consistency in the application of emerging policies and processes.”

In recent months Wolters Kluwer has signed a number of IFRS 9 customers. Just yesterday, for example, Canada’s Equitable Bank selected the company’s OneSumX® Finance, Risk and Reporting solution to manage regulatory and supervisory expectations for its credit and capital management processes, as well as to automate its IFRS 9 requirements.

And in December The Swedish Export Credit Corporation (SEK) also revealed it has chosen Wolters Kluwer’s OneSumX to provide its software for IFRS 9 implementation and reporting.

According to Wolters Kluwer, OneSumX for IFRS addresses the specific methodologies and calculations of IFRS, particularly fair value and amortized cost, impairment and hedge accounting, all of which are continuously evolving. “The solution’s modularity and flexibility enable firms to benefit from certified off-the-shelf functionality which can be tailored to deliver the most effective implementation for their specific situation,” the vendor adds.