IFRS 9 packs bigger punch than Basel changes, say bankers

Capital hit from new loan loss accounting rules to rival incoming Basel regulations

New accounting standards set to have greater impact than other looming regulations

New accounting standards set to take effect in 18 months' time are expected to have an even greater impact on banks' capital levels and balance sheets than any other regulation coming online, according to bankers.

International Financial Reporting Standard 9 (IFRS 9), which is set to go live in January 2018, will introduce forward-looking expected loss accounting for assets such as impaired loans. Estimates are that it could increase capital requirements by 35%.

"The biggest impact of them all – bigger than Basel – is IFRS 9. It is very technical; it is kind of boring; but its impact is huge," said Adrian Docherty, head of financial institutions group advisory at BNP Paribas, speaking at the 2016 European Financial Congress in Sopot, Poland on June 14.

Docherty was responding to a question about which upcoming changes banks see as being the most capital consumptive. New Basel regulations include the Fundamental review of the trading book (FRTB), which industry groups have estimated could raise capital requirements by between 50% and 140% from current levels.

In a speech at a London conference in September last year, Hans Hoogervorst, chairman of the International Accounting Standards Board, estimated that the capital impact would be in "the order of around 35%". According to a survey of global banks conducted by Deloitte on the potential impact of IFRS 9 on banks' capital positions, most banks reported an impact below 50%, according to Dariusz Szkaradek, a partner at Deloitte Poland, also speaking on the panel in Sopot. He said the Polish banking sector would have to raise around 8 billion zloty ($2 billion) of capital to cover the IFRS changes.

This is pro-cyclical. If we enter a stressed period – which we will – we'll see massive swings in the reported solvency of banks
Adrian Docherty, BNP Paribas

"IFRS 9 is going to quite probably be one of the largest impacts. It is going to introduce a new concept of the forward-looking provision, and for most non-performing loans you have to calculate the lifetime provision," said Stefano Santini, chief financial officer at Poland's Bank Pekao.

"Also under IFRS 9 there is additional impact because of the volatility it will introduce in balance sheets," he added.

IFRS 9 is a departure from the previous International Accounting Standard 39, which didn't recognise losses until there was evidence an asset had become impaired. IFRS 9 requires banks to immediately set aside 12 months of expected credit losses on unimpaired assets. Then if the credit risk on the asset increases, it would have to set aside lifetime expected losses. A conflict with the drafting of the new FRTB regulations does not help matters, as rules meant to give some relief to loan loss provisions don't cover lifetime expected losses.

"IFRS 9 will have an impact of increasing the provisions needs and needs to be taken into account when planning for future capital," said Jukka Vesala, director general of the micro-prudential supervision III unit at the European Central Bank.

The impact of the new accounting standards goes beyond capital increases and will lead to increased balance sheet volatility and greater complexity, say bankers. Estimates of expected credit losses have been difficult to calculate, as IFRS 9 says only that banks should provide "an estimate of expected credit losses to reflect an unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes".

"The impact is threefold," said BNP Paribas' Docherty. "First, there is complexity. We know from Basel and our own banking regulations that we cannot deal with internal model complexity – they are not comparable, we can't understand the data and the market loses confidence. Guess what? The complexity is now in accounting, which is the foundation for all financial analysis. Second, there is subjectivity. You have two banks that have the same economic profile but report different numbers – one makes a bit of a profit, one makes a bit of a loss. How do we deal with that? And third, this is pro-cyclical. If we enter a stressed period – which we will – we'll see massive swings in the reported solvency of banks."

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