IFRS 9 explained
Standard Bank's Stephen Brickett and Paul Fallon explain IFRS 9 and what it means for CFOs
Stephen Brickett, Executive: Group Financial Accountant, and Paul Fallon, Executive: Group Risk, have been joint project leads of Standard Bank’s IFRS 9 – Financial Instruments’ (IFRS 9) implementation project since December 2013. In a nutshell, IFRS 9 is the new financial instrument accounting standard that includes requirements for the classification, measurement and impairment of financial assets. It became effective as of 1 January 2018, and is mandatory for all listed companies in South Africa.
Stephen explains: “The most notable change is that of IFRS 9’s expected credit loss impairment requirements. The financial crisis demonstrated that certain banks did not have sufficient impairment provisions and, following the financial crisis, were required to recognise significant additional impairments – this is what some have termed as the ‘cliff effect’ or ‘too little too late’. While South African banks were fairly immune to the financial crisis, partly as a result of the conservative application of the existing accounting rules, some international banks were significantly under-provided, which ultimately led to many financial institutions getting into trouble. Problems in the accounting standards, notably the recognition of impairments based on an incurred event, were pinpointed as contributors to the financial crisis, which ultimately resulted in the new financial instruments accounting standard. With IFRS 9 we will now need to forecast expected losses further into the future, which will potentially result in additional impairments being brought onto the balance sheet.”
Stephen adds that IFRS 9, notably the new expected loss impairment requirements, has been a large project; one that spans the entire Standard Bank Group, including its African regions and all its subsidiaries. While he says that “the impact of IFRS 9 will result in a higher stock of balance sheet impairment provisions”, he is quick to point out that this is merely because of the change in the accounting rules, and does not mean that there is deterioration in the quality of the group’s lending book. He clarifies it quite succinctly by saying:
“At the end of the day, the ultimate loss you experience with loans to clients will not change because of the new accounting requirements. If a client is going to default, the ultimate cash loss under both accounting rule sets is identical. All we are talking about here is the pattern of how we recognise those losses, with more recognised earlier.”
Stephen notes that IFRS 9 affects the banking worlds of both finance and credit, and says having both those areas leading and working on the project has yielded numerous benefits. Paul explains: “Even though IFRS 9 is a finance standard, the risk team has to determine the credit quality of our loan books and, based on that credit quality, what the future losses we can expect. We have specialist teams that do analytics and create mathematical models that determine the credit quality of each loan and from that determine the future expected losses that are required to be recognised in the group’s income statement.”
The business impacts of IFRS 9
According to Paul, there has been much talk in the industry on the business impact that IFRS 9 will have, particularly with regards to pricing. “I don’t think there will be much impact on pricing as the ultimate credit loss is identical under both the existing accounting standard and IFRS 9 – and that is what one prices for,” he says. “Perhaps there could be some adjustments because of the dilution impact on the bank’s capital, which will make banks think more carefully around higher risk loans. This is because of the higher probability of the exposure’s credit risk deteriorating, which will result in higher impairments. We will also need to think how loans are structured or offered to clients, such as the nature and extent of loan facilities and underlying collateral requirements.” He adds that the project team has been quantifying what the IFRS 9 impact is expected to be, which has positioned the group to now more accurately determine the impact on its business.
According to Stephen, the team has spent time considering what shareholders, analysts and other stakeholders need to understand from an IFRS 9 perspective, and what information the group should be disclosing. Standard Bank is expected to be the first of the large banks in South Africa to communicate its final impact, he says, and because the stock of balance sheet impairment provisions is going to increase, it is important to clearly explain the reasons for the change.
Paul states that IFRS 9 will affect key financial outcomes such as earnings and levels of capital.
“The income statement is likely to be more volatile due to drivers that include changes in the credit risk of exposures and changes in the economic outlook, as well as the relative change in the size of a lending book from one balance sheet date to the next."
"A further important impact will be higher day one impairments associated with higher loan book growth – this is a type of ‘tax’ on loan book growth and will need to be considered,” Paul says. He adds that IFRS 9 could mean a further review of the bank’s risk appetite, based on its forward-looking views.
According to Stephen, it will also have implications for tax authorities. “We have had extensive discussions with the relevant tax authorities – both in South Africa in our Africa regions. While the tax legislation typically does not have an effect on the group’s reserves, changes in the level of impairments and the potentially more volatile impact to the income statement in future years will have a direct impact on tax, notably in the timing of tax cash flows,” he says. He explains that the impact of IFRS 9 on tax also has capital implications, as the bank is likely to recognise greater deferred tax assets on transition to IFRS 9, which will have a dilutionary impact on the bank’s capital. The tax impact and the ultimate impact on capital are items that the bank is considering in terms of the impact on its business and its shareholders, he adds.
CFOs and preparation for IFRS 9
Asked what CFOs should be aware of, Paul says that this is more than just accounting and reporting. “Being a bank CFO is going to become more complicated,” he says. More specifically he adds: “There are more drivers that will affect impairments under IFRS 9 than the existing accounting requirements. Notably, the new requirements are more judgmental based and will hence create additional volatility in reported earnings. CFOs will need to better understand the links between credit risk, accounting, tax, and capital requirements, and the ultimate impact on the group’s financial results and position. There is also likely to be significant engagement with one’s auditors in terms of agreeing on judgements, methodologies, mathematical models, and future economic expectations.”
Stephen believes it is important that all CFOs – not just CFOs of banks – know what the drivers of IFRS 9 are and how the new accounting rules will affect them. This is because almost all companies have lending or accounts receivable exposures on their books. He says:
“A CFO’s current focus should be on getting ready for the change to IFRS 9 and to be able to engage with stakeholders such as analysts, tax authorities, investors and other stakeholders so that they understand the change."
Paul adds that CFOs should also realise that IFRS 9 presents a one-time requirement to correctly account for the change between the existing and new accounting requirements within reserves. If this is not done correctly, a company’s future earnings will be affected, he notes.
A changed landscape
According to Stephen, Standard Bank has been running both the new IFRS 9 models and the existing accounting requirements simultaneously, to coach the organisation so that it can seamlessly turn off the old and turn on the new in January 2018. “It is about training and preparing our people – not just in their respective fields – but also with new skills and insights which will ultimately assist the group in better managing its credit risk under the new accounting regime. It is also about ensuring that there is sufficient preparation to adopt the new requirements as business-as-usual,” he explains.
“It is going to be interesting when banks and other entities with large loan books present their financial results – not only next year for the first time but also each year thereafter,” says Paul. “This is because each entity could have different economic outlooks, which will make comparisons between the entities more difficult. There will, of course, need to be additional financial disclosures to describe the expected economic outlook, which banks and other entities have not had to do previously.”
Ultimately, the pair sum it up by saying that IFRS 9 is not just about debits and credits – it has many other very real implications for an entity and its stakeholders, too.