16, Sir William Newton Street
Port Louis, Mauritius
Robust and highly capitalised, local banks were able to withstand the shock at the height of the 2007-08 financial crisis. Today, as they are called upon to participate fully in the economic recovery, their resilience is once again being tested. To mitigate the risks, particularly those related to doubtful loans, they can rely on IFRS 9, to help them manage their risks.
Since 1 January 2018, IFRS 9 has changed the way in which companies must prepare their financial statements. They are now required to switch to an impairment model for credit risk. In this post COVID-19 period where banks are particularly vulnerable, how can IFRS 9 help them to better provision for bad debts, especially for the segment B?
COVID-19 has brought to the table a new set of challenges with negative growth, falling consumption, increasing unemployment and rising inflation among others. Thus, the variables used in the development of financial models are no longer valid because of the new challenges that have emerged and are affecting the banking sector as a whole.
As far as IFRS 9 is concerned, it is primarily focused on the treatment of financial data. The revised IFRS 9 models, in fact, factor in the significant increase in credit risk pushing up the probabilities of default that is being reflected in higher impairment provisions for both Segment A and Segment B.
Can it be said that IFRS 9 is a valuable tool for internal control departments?
Credit risk is one of the most significant risks that a bank faces. IFRS 9 has come up with a new way of assessing the level of risks and the relative provisions that need to be recognised. What can be said is that a high level of expert judgement is invariably required in assessing a credit proposal and determining the appropriate level of credit risk related provisions. IFRS 9, however, requires that we make provisions from the very first day a loan is disbursed. The level of provisions depends on various factors, such as the client, the nature of his/her business, his/her past behaviour, while adopting a forward looking view that again requires the use of expert judgement. The provision level should then be regularly reassessed in line with changes in the operating environment.
How can IFRS 9 contribute to strengthening the stability of the financial system?
IFRS 9 requires financial data modelling. If the models are given a proper framework, and are tested and reviewed regularly, they will undoubtedly contribute to the stability of the financial system. The challenge today is that each bank has its own IFRS 9 model that reflects its unique portfolios which leads to a lack of consistency within the industry. As an example, for two similar exposures towards the same company, two different banks will apply different provision levels and the amounts can sometimes vary considerably. But what we have been seeing, as general rule, is an overall increase in provision levels.
How does IFRS 9 differ from IAS 39?
The main change brought about by IFRS 9 compared to IAS 39 relates to the impairment of financial assets. IFRS 9 requires that forward-looking information be used in calculating the appropriate level of provisions to be carried for an asset. Staging is also a new concept that allows the calculation of expected losses over 12 months and over the entire duration of the loan. Other changes introduced are less significant.
Do you think that financial reporting standards used to be too complex?
Financial Reporting standards are becoming more and more demanding and complex. As readers of Financial Statements are today well-informed and sophisticated, more and more disclosures are required in the annual reports which are used for deeper analysis. As a result, through enhanced reporting, greater transparency is achieved and comparisons become much more meaningful.
The new standard has impacted the financial operations of banks. But with hindsight, don’t you think that this transition was necessary, especially at a time when banks need to be more rigorous on credit risks?
IFRS 9 was brought forward following the bad experience during the 2007/2008 financial crisis, when it was felt that the provisions of IAS 39 did not really reflect the credit risk sitting on banks’ balance sheets. Since the relevance of IAS 39 had become questionable, it was absolutely necessary to move to a new framework. The transition from IAS 39 to IFRS 9 resulted in an overall increase in impairment provisions worldwide, including Mauritius. The increased provision levels provide better cushion for difficult times, which is good for the industry as a whole.
Chief Financial Officer at Bank One
Business Magazine, 19 August 2020
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