In a previous post we discussed how IFRS 9 will affect commodity firms through hedge accounting programs. Generally speaking, as pointed out by Thack Brown in this post, IFRS 9 will affect financial and non-financial corporates through:
1-New classification and measurement principles for financial assets,
2- New impairment models that will accelerate recognition of credit losses,
3-Improved model of hedge accounting.
As we can see, commodity firms and other non-financial corporates will be most affected by the new hedge accounting rule, while Banks and other financial institutions are impacted by the new credit loss model.
To respond to the new requirement, Banks are currently in the process of implementing a new credit loss (ECL) model. However, experts have warned that the new accounting standard will increase the Banks’ revenue volatility and have significant impact on their regulatory capital and provisions. In fact, early this year, Tom Porter wrote
“Capital headwinds in a downturn could be much more severe under IFRS9,” Barclays analysts wrote in a note on Monday, adding that the changes could knock as much as 300bp off industry-wide common equity tier 1 ratios during a typical downturn. This would be around three times higher than under the current system.
“There will be plenty of instances when IFRS9 appears to smooth bank earnings,” they said. “But in a bad enough downturn – or where there’s a swift enough deterioration in credit quality – the provisions taken in good times won’t be enough to cope.” Read more
To help smooth out the negative impact of the new accounting regime, the Basel Committee on Banking Supervision recently released a statement regarding the regulatory treatment of accounting provisions and standards for transitional arrangements. It said
Given the limited time until the effective date of IFRS 9 (which will take effect on 1 January 2018) the Committee will retain the current regulatory treatment of provisions under the Basel framework for an interim period. This will allow the Committee to consider more thoroughly the longer-term regulatory treatment of provisions. Jurisdictions may adopt transitional arrangements to smooth any potential significant negative impact on regulatory capital arising from the introduction of ECL accounting. Read more
This means that Banks can adopt a transition period, thus allowing them to be able to mitigate the negative impact of ECL accounting, which, according to the previous article, can be as high as 300 bp during a downturn.
Developing and implementing a robust model is not always easy. We believe that after a transition period, the new ECL model will bring more stability to the financial system.