Wolters Kluwer Financial Services Solutions: Breaking down IFRS 9 Implementation
Posted: 1 July 2016 | Source: Wolters Kluwer
The ultimate aim of IFRS 9 is to encourage banks to assess credit and risk in a more comprehensive, prospective way that takes myriad internal and external factors into account in order to spot trouble before it arrives. IFRS 9, which banks are free to implement now and will be mandatory at the start of 2018, although there will be wiggle room in some locales, features two key ways to achieve that. One involves the way that instruments are classified, the other concerns the treatment of credit impairments.
IFRS 9 requires each instrument to be placed in one of three categories depending on the type of asset it is and the business model under which it’s owned. Loans and other debt instruments that firms intend to hold to maturity and collect interest on – the stuff of traditional retail or commercial banking – are carried at amortized cost (provided these firms pass the Solely Payment of Principal and Interest test – aka the SPPI test). Equity and debt instruments held as portfolio investments are carried at fair value through profit and loss, essentially a way to mark them to market periodically. Other assets, as well as conventional debt and equity owned in certain unconventional circumstances, are placed in the third category, fair value through other comprehensive income.
The other significant new wrinkle in IFRS 9 is the calculation of expected credit losses (ECL). In a departure from the traditional incurred-loss impairment model that acknowledges a loss only after a default or other triggering event, banks will be required to estimate a loss from the moment an asset appears on the balance sheet and to update the estimate when facts warrant it. The estimate will cover a 12 month probability of default period for assets in reasonable shape and over their full lifetime in the case of more troubled assets.
This future-is-now model is bound to have a material impact on the balance sheets – and therefore the reputations – of many banks that will become immediately apparent to boards, investors and other stakeholders. The ability to get it right when making forecasts and accounting for risk will matter as never before because the consequences of getting it wrong are bound to be greater than ever. Firms that succeed are likely to have a demonstrable edge over ill-prepared competitors who find themselves wandering aimlessly on the road to tomorrow, encountering obstacles along the way in the form of challenges from regulators, disdain from investors and customers and ultimately reduced operating efficiency and profitability.
To comply with IFRS 9 – and avoid being among the firms in the second group – banks will have to reassess their internal operations. In particular they will have to dismantle barriers between departments such as Finance and Risk, as well as spruce up data management capabilities in order to make more accurate and longer-term credit assessments. These changes will come in handy not just for implementing IFRS 9 but other elements of the new supervisory architecture, too. With so much at stake, introducing IFRS 9 must be an urgent priority across the industry. And yet… Although many organizations are engaged in intensive preparations, an unsettlingly high proportion, appear nowhere near ready to put the standard into practice. A Wolters Kluwer survey undertaken in conjunction with Risk.net in May 2016 found that 15% of institutions had not even begun the implementation process, while 34% were at gap analysis phase.
Wherever they may be on the road to IFRS 9 readiness, firms are sure to be working hard in the months ahead to evaluate their data systems and adopt appropriate solutions. Prepared with the input of Wolters Kluwer sector experts, this buyer’s guide aims to assist companies in this vital process. It will touch on some of the common technical and operational issues involved in IFRS 9 projects, outlining areas of best practice and common pitfalls. It also will identify key features and capabilities that institutions should look for as they consider solutions for integrating IFRS 9 into their everyday activities.