IFRS 9 CECL Financial Instruments – Executive Profile

Following financial crisis of 2008-2009, the G20 tasked global accounting standard setters to create a global standard for financial instruments. Subsequently, the IASB and FASB worked together to develop new financial statements standards. The IASB decided to accelerate its project to replace most of the guidance as set in IAS 39 and introduced the new standard sub-divided in three major phases;

·        Classification and measurement

·        Impairment

·        Hedging

In particular, interested parties such as the G20 highlighted the areas below as areas in need of consideration:

·         the timeliness of recognition of expected credit losses;

·        complexity of multiple impairment models; and

·        own credit.

The IASB has conducted an extensive program of outreach, including hundreds of meetings with users, preparers of financial statements and others. Based on feedback received, the Board decided that the most effective way to address such issues and improve the ability of users of financial statements to better understand the information about the amounts, timing and uncertainty of future cash flows is to replace the existing classification and measurement categories for financial assets.

The initial converged model proposed recognition of full expected credit loss (ECL) be delayed until there was significant deterioration in credit risk. FASB eventually adopted current expected credit losses (CECL) model which generally calls for immediate recognition of all expected credit losses. Henceforth, the impairment models for financial assets under US GAAP and IFRS will not be converged.

In July 2014, the IASB published IFRS 9 – Financial Instruments standard with effective date set at January 1st, 2018. Banks and financial institutions began to pay greater attention to the new accounting standard.

As it has become obvious that the effective date of IFRS 17 Insurance Contracts can no longer be aligned with the effective date of IFRS 9 Financial Instruments there have been calls for the IASB to delay application of IFRS 9 for insurance activities and align the effective date of IFRS 9 for those activities with the effective date of the new insurance contracts standard.

IASB is expected to issue IFRS 17, the proposed new accounting standard for insurance contracts, later this year. If this happens, the new standards are likely to be effective from 2021.

IFRS 9 allows entities to designate a financial asset or financial liability at fair value through profit or loss upon initial recognition. This option is referred to as the “Fair Value Option.” An entity may, at initial recognition, irrevocably designate a financial asset as measured at fair value through profit or loss if doing so eliminates or significantly reduces a measurement or recognition inconsistency, sometimes referred to as an ‘accounting mismatch’, that would otherwise arise from measuring assets or liabilities or recognizing the gains and losses on them on different bases.

The Basel Committee on Banking Supervision – BCBS has issued separate papers on a number of related topics in the area of credit risk, including credit risk modelling and credit risk management. Banking supervisors have a natural interest in promoting the use of sound and prudent credit risk practices by banks and financial institutions. Experience indicates that a significant cause of bank failures is poor credit quality and lack of deficient credit risk assessment and measurement practices. Failure to identify and recognize increases in credit risk in a timely manner can aggravate and prolong the problem. Inadequate credit risk policies and procedures may lead to delayed recognition and measurement of increases in credit risk, which affects the capital adequacy of banks and hampers the proper assessment and control of a bank’s credit risk exposure. The bank risk management function’s involvement in the assessment and measurement of accounting ECL is essential to ensuring adequate allowances in accordance with IFRS 9.

Implementation budget for the standard is on the rise because steps towards IFRS 9 compliance is not supposed to be taken in isolation, but rather in the context of existing regulatory pressures. With Basel III, CCAR, stress testing, BCBS2 239 and other requirements, financial institutions are already exposed to elevated levels of regulatory scrutiny and devoting substantial attention to compliance efforts. According to a survey by Deloitte, most global banks estimate new IFRS 9 /FASB CECL rules on credit exposures will result in loan loss provisions increasing by up to 50% across asset classes.

Key jurisdictions will implement similar approaches to IFRS 9 with most relevant being FASB’s Current Expected Credit Loss project. These initiatives are to combine and broaden the scope of banks and financial institutions that implement ECL-based impairment approaches with aggravated levels of total anticipated implementation budgets. Most global banks and financial institutions estimate new IFRS 9/FASB CECL rules on credit exposure will result in loan loss provisions increased across asset classes, considering transition impact in 2018

The move to ECL accounting frameworks by accounting standard setters is a crucial step forward in resolving the weakness identified during the financial crisis that credit loss recognition was too little, too late. The development of the IFRS 9 ECL accounting framework is also consistent with the April 2009 call by the G20 Leaders for accounting standard setters to “strengthen accounting recognition of loan loss provisions by incorporating a broader range of credit information”.

Due consideration should also be given to the application of the principle of materiality. However, this should not result in individual exposures or portfolios being considered immaterial if, cumulatively, these represent a material exposure to the bank. In addition, materiality should not be assessed only based on the potential impact on the profit or loss statement at the reporting date. For instance, large portfolio(s) of high-quality credit exposures should be considered material.

Citation:

This paper is an extract compilation from the following;

·        The website – The International Accounting Standards Board – IASB

·        IFRS 17 A Simplified approach? – KPMG (2017)

·        World Standard-Setters Conference – IASB (2016)

·        The FASB’s New Financial Instruments Impairment Model – PwC (2016)

·        Guideline - Office of Superintendent of Financial Institutions Canada (2016)

·        Fifth Global Banking IFRS Survey: Finding Your Way – Deloitte (2015)

·        Achieving Optimal IFRS 9 Compliance - SAS Institute (2015)