The banks across GCC are facing tighter regulatory pressures as they prepare to meet Basel III capital rules and International Financial Reporting Standards 9 (IFRS 9), according to analysts.

The implementation on IFRS strongly affects the way credit losses are recognised in the balance sheet and profit and loss (P & L) statement. While impairments are currently based on “incurred losses”, IFRS 9 introduces an approach based on future expectations, namely expected losses (EL).

The main impact on banks is the need to recognise EL for all financial products, and at individual and grouped-asset levels. Banks will have to update their calculation at each reporting date to reflect changes in the credit quality of their assets. This will significantly increase the number and frequency of impairment quantifications that must be undertaken and the amount of data that must be processed for such purpose.

At a recent joint briefing session organised by Dubai Financial Services Authority (DFSA) and the Institute of Chartered Accountants in England and Wales (ICAEW) Panellists said that IFRS 9 introduces changes to the classification, measurement and impairment assessment requirements for financial instruments as well as new requirements for hedge accounting. It will change the way in which banks and other financial institutions account for loan losses on their balance sheets, imposing a longer, more forward-thinking view.

“IFRS 9 is a comprehensive response to the financial crisis and is intended to provide a more accurate and timely presentation of financial institution reporting, particularly in relation to loan losses. While preparation for IFRS 9 requires time and money, it will bring financial institutions into a new world of forecasting,” said Michael Armstrong, FCA and ICAEW Regional Director for the Middle East, Africa and South Asia (MEASA)

Challenges

The new standard on risk recognition revises guidance on the classification of financial assets, and supplements the new hedge accounting principles published in 2013.

Emirates Institute for Banking and Financial Studies (EIBFS), recently organised an interactive workshop attended by more than 60 senior bankers and finance officers to discuss strategies being deployed by banks in the UAE to address challenges associated with the implementation of IFRS 9.

Bankers say IFRS 9 is one of the most complex accounting standards ever to be issued and banks need to be ready for the multi-faceted challenges associated with its implementation. He added that the business model tests and the decision trees underlying classification, initial and subsequent measurement must be woven into financial control and risk management processes, and properly documented.

“Under the new standard, impairment accounting and loan loss calculation have become highly complex — they are more art than science, and require expert judgement. Comparability between banks is severely impacted by how judgement is exercised in areas where there is room for interpretation. An added complexity is the interplay with regulatory or Basel III definitions. Regulators and auditors must be satisfied that the implementation approach meets their expectations,” said Madhukar Shenoy, Partner at PwC Middle East

To match regulators’ expectations, Shenoy recommended that banks must ensure their auditors and regulators are kept aware of their IFRS 9 implementation plans and consulted on a timely basis. He summed up that ensuring anadequate governance over the IFRS 9 related models, audit trail and documentation, and robust and verifiable processes go a long way in satisfying regulators.

 

Factbox: Expensive with balance sheet impact

Adopting International Financial Reporting Standards 9 (IFRS 9) will require a lot of time, effort and money. The new standard requires banks to provide for expected credit losses over the lifetime of the loan on the date the loan is first recognised, based on the level of default expected over the next 12 months. Where credit risk is assumed to significantly increase, loan loss provisioning must be recognised based on the level of defaults expected over the expected life of the loan. This should lead to higher provisions, more complexity and deeper risk management involvement.

IFRS 9 requires entities to consider macroeconomic factors in determining provisioning levels. This requirement might be difficult and complicated for multinational organisations operating in different jurisdictions. Experts say management of banks and financial institutions should not to wait for regulators to make suggestions about their reporting practices. Instead, they should take a judgement call, forecast macroeconomic factors and run their own risk scenarios.

“IFRS 9 will, in my view, influence the type of business that is done. Underwriting would be impacted by the need for recognition of assets held on amortised costs or on fair value through profit and loss, and the provisioning requirements. The former would become a significant consideration for the nature of the asset to be booked. The provisioning requirements of the new standard are stringent regarding the quality and early recognition of the problems in a loan portfolio,” said Sumit Malik, Head of Credit at the National Bank of Fujairah.

Bankers say apart from the implementation costs, the new provision requirements and restrictions on asset bookings will reflect on profits. “Given these changes, assets with long tenors and low pricing could drain profitability. We have also seen existing products in the market with no fixed expiry dates, on which pricing would be affected by the new standards. As Credit Risk Officers, we need to be mindful of these changes and accept businesses that not only meet these principles, but also their structure and pricing to compensate the cost of risk,” said Malik

source : gulfnews