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All about IFRS 9 in 5 minutes
IFRS 9 in summary
The International Financial Reports Standards (IFRS) are a set of accounting standards being implemented by different countries across the world, which are gradually replacing the old International Accounting Standards (IAS). Their introduction heralds a major change in accounting procedures for financial institutions.
One of the standards that is going to have the biggest impact on banks is IFRS 9 (Financial Instruments) which replaces IAS 39 (Financial Instruments: Recognition and Measurement) and becomes mandatory for annual periods from 1 January 2018 onwards.
Implementation of this new single, integrated standard is being done in three phases:
- Classification & measurement of financial instruments
- Impairment of financial assets
- Hedge accounting
Main area of IFRS 9
The International Financial Reports Standards (IFRS) and the International Accounting Standards Board (IASB) detail the requirements of the IFRS 9 standard as follows:
IFRS 9 classification and measurement
Classification determines how financial assets and financial liabilities are accounted for in financial statements and, in particular, how they are measured on an ongoing basis. IFRS 9 introduces a logical approach for the classification of financial assets, which is driven by cash flow characteristics and the business model in which an asset is held. This single, principle-based approach replaces existing rule-based requirements that are considered to be overly complex and difficult to apply. The new model also results in a single impairment model being applied to all financial instruments, thereby removing a source of complexity associated with previous accounting requirements.
IFRS 9 impairment
During the financial crisis, the delayed recognition of credit losses on loans (and other financial instruments) was identified as a weakness in existing accounting standards. As part of IFRS 9, the IASB has introduced a new, expected-loss impairment model that will require more timely recognition of expected credit losses. Specifically, the new standard requires entities to account for expected credit losses from the moment when financial instruments are first identified. IFRS 9 acknowledges the full lifetime expected losses on a more timely basis.
IFRS 9 hedge accounting
IFRS 9 introduces a substantially reformed model for hedge accounting, with enhanced disclosures about risk management activity. The IFRS 9 hedge accounting model is a significant overhaul that aligns accounting treatment with risk management activities, enabling entities to better reflect these activities in their financial statements. In addition, as a result of these changes, users of the financial statements will be provided with better information about risk management and the effect of hedge accounting on the financial statements.
Key challenges of IFRS 9
The new standard incorporates a forward looking expected credit loss (ECL) model for the calculation of provisions. This will have an immediate impact on a bank’s balance sheet and earnings on the day it switches over to the new standard. The key challenges for banks are as follows:
1. Financial instrument classification
Under IFRS 9, banks need to classify all instruments into one of the following three categories: amortized cost, fair value through comprehensive income (FVOCI), and fair value through profit and loss (FVPTL).
2. Stage identification
This aspect of IFRS 9 is completely new for credit provisioning. It will require banks to assign a stage to each account that has been classified for amortized cost or FVOCI. Stage assignment is based on the account’s credit risk characteristics.
3. Provision calculation
IFRS 9 provides fairly detailed guidelines on the calculation of items such as the effective interest rate (EIR), the credit-adjusted effective interest rate, the effective interest spread (EIS); and the expected credit loss (ECL), based on forward-looking assessments.
4. Credit modelling
Banks will have to use a forward-looking approach in estimating point-in-time probability default (PD) and loss-given default (LGD) for the purpose of provision calculations. In addition, banks will have to build and calibrate point-in-time models, which will require significant efforts.
Once banks have started to make all these calculations on an account level granularity, they will also need to be able to report and analyse not just point-in-time data but also trends in how the provisions have evolved across all accounts.
The following assets will give you detailed information on the key challenges that banks face:
Key data requirements of IFRS 9
Banks need to institute an appropriate data governance program to originate and source quality data at a highly granular level, for IFRS 9 processing. They need to consider historical, current, and forward looking forecasts in various areas for ECL computations.