In a nutshell, the International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB) that is becoming the de facto global standard for financial reporting. And more specifically, IFRS 9 is the IASB’s response to the financial crisis; the package of improvements introduced by IFRS 9 includes a logical model for classification and measurement, a single, forward-looking ‘expected loss’ impairment model and a substantially-reformed approach to hedge accounting.
Ok, we got the background out of the way. Now onto the more important information: how is IFRS 9 benefiting banks? With the inundation of regulatory requirements for financial institutions, we have to find the silver lining somewhere! While all of the requirements are painstaking, they can, and should, have valid business benefits.
The IFRS 9 impairment guidelines are posing a lot of practical challenges to financial services institutions to implement, but there are a number of positive effects that cannot be overlooked. Here are what I find to be the top 3 reasons why IFRS 9 is a good thing for financial institutions.
#1 Credit appraisal and pre-sanction processes
Going forward, financial institutions are expected to tighten their credit appraisal processes. Time and again improper and inadequate credit appraisal processes were observed as the main internal cause for loan accounts turning out bad, amongst other external causes such as economic slowdown, willful defaults and so on. Given the requirement of forward looking expected credit losses, financial institutions are about to look at further strengthening of their underwriting standards and credit appraisal processes.
#2 Closely monitor assets
Financial institutions are expected to closely monitor the “watch-list” category of assets that are likely to slip into the category of “under-performing or credit impaired” to avoid assets being classified into “stage 2 or 3”. In addition, they are expected to make all efforts to ensure that the assets classified into stage 1 as of last reporting date do not migrate to stage 2 or 3 owing to the Lifetime ECL impact.
Needless to say, these efforts will be initiated on a pro-active basis in order to safeguard an institution’s distributable profits, brand value and keep the NPA (Non-Performing Assets) levels under control.
All of these are expected to result in further strengthening of existing post disbursal follow up processes and set to streamline the collection efforts.
#3 Capital & business planning
IFRS 9 impairment guidelines have a direct effect on the retained earnings and thus, the bank’s capital. Given the capital constraints, it is quite likely that each line of business within an institution be mandated to efficiently utilize the scarce capital resources allocated to them and maximize profits.
Other positive effects
In conclusion, IFRS 9 with its forward-looking impairment model is expected to further augment the efficiency of the banking system. It can be concluded that this impairment model has served its main purpose if another financial crisis is averted and thereby the interests of shareholders and general public are safeguarded. Only time can prove the effectiveness of the revised set of guidelines.
Although IFRS 9 is an accounting standard, it is expected to play its part in strengthening the financial institution’s credit risk management system in particular and bringing about a sound banking system at large.
Krishnamurthy Venkatraman is a Senior Principal Product Manager for Oracle Financial Services Analytical Applications. For more information, contact Geetika Chopra.
The views expressed herein are the views of the author and not necessarily the views of the employer.