IFRS 9, the new financial instruments standard, is effective for periods beginning on or after 1 January 2018. This standard presents banks with the biggest change in financial reporting that they have faced and it is envisaged that the complexity and cost of implementing its requirements will be broadly equivalent to their adopting IFRS for the first time in 2005. In 2015 and 2016, regulators and other bodies expressed their expectations that banks would present the quantitative impact of IFRS 9 in their 2017 interim financial reports at the latest; however, only a few have. In light of this backdrop, and the fact that the final version of the standard was issued in mid-2014, why is there a lack of numerical disclosure?
The short answer is that IFRS 9 is indeed a challenging standard to implement. The recognition of future losses as at a reporting date is a first for accounting standards. Throw in the need to identify multiple-economic scenarios, develop forward looking information and probability weight the outcomes only exacerbates the task. Another short answer is that the implementation of IFRS 9 does not represent the only change programme that banks have faced recently (eg MiFID II, the Senior Managers Regime, et al). While both of these ‘answers’ are true, part of the problem is a hesitation to start implementing IFRS 9, just like my starting to write this article. But this is the same for most things in life, not knowing how the task at hand is going to pan out.
The message I have for all preparers out there who have not yet started or are in the initial stages is to just start. Our experience of working with banks is that once they do, they make some good progress quite quickly. A key thing is to involve the right people early; including people from credit and risk and not just finance. Another aspect is the value in assessing what is being currently being done for the purposes of incurred loss under IAS 39. This is so as not to start from a blank piece of paper but care needs to be exercised in using this as starting point - so review this from the perspective of where one needs to get to under IFRS 9. This extends to current procedures as well as governance, risk and control frameworks that banks have in place.
For example, a typical control in a bank is a periodic review of its customer’s creditworthiness. This review could be extended to incorporate an assessment of whether there has qualitatively been a significant increase in credit risk at the reporting date. Another example relates to data, whereby at the beginning of each year, management would come up with their expected economic forecast. They would then identify the most comparable historical year in terms of economic conditions that they expect to manifest and use this as a starting point. Credit committees could periodically reassess their outlook of the economy and probabilities of default and move the curves for these up and down based on their expectations.
One more thing to bear in mind is that it is not pens down once the first set of IFRS 9 financial statements have been issued. This is because what is disclosed in those financial statements will require a fair amount of refinement, particularly given preparers would then have sight of what their peers have done. Expectations will become clearer and the importance of qualitative disclosures to explain judgements will be more essential so as to minimise ‘false positives’. And, of course, processes for estimating expected losses will be improved based on the lessons learned from the actual losses that arise. This will just be the beginning of the journey.
If you have any questions, or would like to discuss the content of the paper further, please get in touch with Mark Spencer.