The IFRS9 Q & A on Prudential Reporting Challenges

22nd April 2018, Bachir El Nakib, Senior Consultant Compliance Alert (LLC)

The International Financial Reporting Standard 9 (IFRS 9) will fundamentally change accounting practices by requiring firms to consider the impact of possible future events when calculating their capital provisions. With implementation set for 1 January 2018, and parallel runs for the larger institutions scheduled to take place just next year, banks are currently at the most intense stage of preparation for the new regulatory standard.


Mohammad I. Fheili - Risk and Capacity Building Specialist: as#Regulations soar, let's do: - just enough not to be accused of#Compliance_Evasion (To unethically avoid); but so much to be effective in #Compliance_Avoidance (To ethically evade), move from Rigid Financial Organization where the #Banking_Model is based on "originate-to-hold" to more fluid organization where the banking model is based on#Traffic (i.e., more transactions, more customers, ...)


According to the Lebanon's Central Bank or Banque du Liban (BDL)'s balance sheet, total assets of the bank reached $118.3 billion at the end of 2017, rising by $15.9 billion which is 16% increase compared with the previous year.

Moreover, the securities' portfolio of the Central Bank increased by $3.4 billion, or 13 percent and reached to $29.3 billion over the same period. The portfolio largely includes subscriptions to treasury bills which are issued by BDL and covered by certificates of deposit (CDs) in lira. Local banks use CDs to lend to the government through the Central Bank.

As reported by Blominvest Bank, gold reserves rose 12% to $11.96 billion driven by increase in the price of gold to $1302.45 / ounce in December 2017 compared with $1158.24 / ounce, last year.

In financial sector, deposits surged by 16% ($13.3 billion), to $97.5 billion. There are different forms of deposits by the banks at BDL which includes lira and dollar deposits, reserve requirements, and certificates of deposit (CDs). Also, The Central Bank doubled loans to the financial sector to $12.7 billion which added $6.3 billion to total assets.

After the financial engineering operations of 2016, the central bank's exposure to the banking sector has improved. However, BDL had to provide short term bridge loans to some of banks which participated in these swap operations in order to top up their liquidity in dollars, because these banks joined the financial scheme, beyond their capacity in dollar liquidity. Today these banks try to collect additional funds by offering appealing interest rates on dollar deposits, in order to pay back the BDL bridge loans, according to a source.

The Financial Engineering Operations

The financial engineering operations was carried out between Banque du Liban (BDL), Lebanon's central bank and commercial banks in summer 2016 with the aim of strengthen banks' balance sheet and to bring in new $-funds to BDL through banks.

According to a report from BDL, the financial engineering mechanism was performed as follows:

  • BDL swapped Lebanese Pound (LBP) treasury bills (TBs) held in its portfolio with equivalent Eurobonds issued by the Ministry of Finance, amounting to USD 2 billion.
  • BDL sold the recently acquired Eurobonds and issued USD Certificates of Deposits (CDs) to commercial banks against fresh USD inflows provided by banks.
  • BDL discounted at 0% an amount equivalent to the previous transaction (Eurobonds and USD CDs) of LBP denominated debt held by commercial banks in their portfolio. This transaction was subject to voluntary 50% haircut on interest in favor of BDL.

Objectives of the Financial Engineering Operations

As stated on the same report, this scheme improved BDL's balance sheet as well as Lebanon's credit profile. Some of the main objectives were achieved by the financial engineering operations are:

  • strengthening BDL's foreign currency assets which have reached to around $41 billion.
  • Banks would be able to constitute additional general reserves ahead of the implementation of IFRS 9 in January 2018 and to reach the BDL targeted capital adequacy ratio of 15% (end 2018), which is above the international capitalization requirements (Basel III).
  • Liquidity in local currency (LBP) has increased which enabled banks to expand their credit portfolio, especially to SMEs.
  • Interest rates have decreased which led to improve the government debt profile by reducing the cost of borrowing and as a result of this improvement, international financial institutions have encouraged their clients (pension funds and asset managers) to invest in Lebanese Eurobonds.
  • The financial engineering mechanism improved the balance of payments by turning a cumulative shortage of $1.7 billion in May 2016 into a cumulative surplus of $555 million in September 2016.
  • Lebanon's rating and outlook has changed from negative to stable.

Economic Growth in Lebanon

Lebanon has a free market economy and non-interventional trade habit. However, it is struggling with negative consequences of regional conflicts such as Syria's civil war and Iran-Saudi tensions, on the country's economy. Lebanon tries to improve its economic situation by increasing investments and exports in 2018. Also, according to Bloomberg website, Lebanon is to sign an agreement with management consulting firm McKinsey & Co. in order to restructuring a new economic vision to improve banking and financial sectors as well as dealing with high rate of unemployment in Lebanon, Economy and Trade Minister, Raed Khoury, said

Lebanon Banking Association opinion dated June 2017: The time is right to return to and discuss the Basel Accords pertaining to banking solvency, since the Basel Commission has accepted the Banking Control Commission of Lebanon (BCCL) as a member of the Basel Consultative Group. The article herein tackles the topics currently under discussion and the positions of major countries in this regard, especially the European Union (EU) and the United States.

First, remember that Lebanon is not one of the 27 countries that are members of the Basel Commission. The Commission includes ten European countries: Germany, France, the U.K., Italy, Spain, Switzerland, Sweden, the Netherlands, Belgium, and Luxembourg, and five countries from the Americas: The U.S., Canada, Mexico, Argentina, and Brazil. Moreover, there are five developed countries from Asia/Oceania: Japan, Australia, South Korea, Hong Kong, and Singapore, and six members from emerging and developing economies: China, India, Indonesia, Russia, South Africa, and Turkey. Saudi Arabia is the only Arab member. The combined banking assets of all member countries account for more than 90 percent of the world’s overall banking assets.

This agreement has been rigorously implemented by Lebanon both in terms of mandatory rates and the implementation period, including the equity of banks and the International Financial Reporting Standard 9 (IFRS 9) requirements. All this comes at a time of deterioration in the level of the State solvency, an escalation in the risks of lending to the economy, worsening of the deficits of foreign trade in goods and services, and of a decline in capital inflows. In such particular circumstances, many people try to score points in public debates by proposing to burden the banks beyond their capacity and without taking these requirements or the financing of the State into account. If it is hard to finance a deficit of $4 billion now, how could funding be secured for a projected annual deficit of nearly $7 billion!  

Lebanon Central Bank (Banque Du Liban), issued its Basic Circular No 143 Addressed to Banks, Financial Institutions, and External Auditors of Basic Decision No 12713 of 7 November 2017 relating to the implementation of International Financial Reporting Standard 9 (IFRS 9), where it stipulated: 

Article 1: As of 1 January 2018, banks and financial institutions are required to apply the International Financial Reporting Standard IFRS 9 (concerning Financial Instruments), and the ensuing amendments of IFRS 7 (concerning Financial Instruments Disclosures), on both separate and consolidated financial statements. Accordingly, banks and financial institutions must set the necessary rulebooks in this respect, including technical ones, and ensure their complete readiness prior to 31 December 2017. 

Article 2: Banks and financial institutions must prepare and document one or more business models that are consistent with IFRS 9 requirements and that reflect the strategy set to manage financial assets and ensure cash flows. 

Saumya Krishna of Deloitte Lebanon: 

Q. What is the key difference between the old and the new approach to impairment?
 In some ways IFRS 9 is much simpler than its predecessor IAS 39. It is principle-based and logical rather than rule-based. It enables accounting to reflect the nature of the financial asset (determined by its cash flow characteristics), the company’s business model (how the assets are managed) and its risk management practice on financial statements. It is forward-looking and ensures a more accurate, and timely assessment of expected losses.

Q. I’m not a financial institution. Does it really impact me?
Yes, if you have any of the following assets (Financial Assets): debt instruments, lease receivables, trade receivables, retention receivables, contracts assets (defined in IFRS 15), related party loans (e.g. loan given to a parent/subsidiary/any related party), construction work in progress and derivatives.

Note: There is no difference between IFRS 9 and IAS 39 when it comes to Financial Assets that are opted at Fair Value Through Profit and Loss (FVTPL) at original recognition.

Q. What is the overall framework of IFRS 9?
 IFRS 9 stands on three pillars:

  1. Classification and measurement: This relates to how a financial asset is accounted for in financial statements and how it is measured on an ongoing basis. It requires an understanding of the characteristic of the financial asset and the purpose of holding it.

    The standard introduces a cash flow and business model test that are typically qualified by trade receivables, vanilla bonds, debt instruments and loan to related parties. As such, these assets will require an impairment assessment and subsequent adjustment to carrying values.

    Equity and Derivatives will continue to be accounted for at fair value. Embedded derivatives are no longer required to be separated from the Financial Assets.
  2. Impairment: Single impairment model based on a forward-looking expected credit loss (ECL) model.
  3. Hedge accounting: IFRS 9 allows more exposure to be hedged and provides for principle-based requirements that are simpler than IAS 39 and aligned with an entity’s risk management strategy.

Q. What is ECL and how will this be estimated?
 Every receivable carries with it some probability of default and, therefore, has an expected loss attached to it.

IFRS 9 introduces new impairment requirements that are based on a forward-looking expected credit loss (ECL) model. In simple terms, it is the present value of probability adjusted estimate of loss that would occur if the asset defaults.

ECL should be based on the nature of the financial asset, financial strength and credibility of the debtor, experience in dealing with similar assets, current macroeconomic conditions, expectations of future trends and behavior, forecasts of relevant variables and judgment.

We know that some companies in the region do not have an advanced understanding of their customers’/borrowers’ financial strength, and credit ratings from agencies are not as readily accessible as in other parts of the world. As such, estimating the ECL

will require a fundamental shift in the internal processes and credit risk management framework of companies to be able to capture, document and analyze relevant qualitative and quantitative factors. In the initial years of implementation, companies would also need to perform data mining to consider and quantify historical loss rates of customers/lessees/borrowers/other debtors.

As such, a positive outcome of IFRS 9 impairment assessment requirements is a necessary shift towards better Know Your Customer (KYC) practices in the region.

Q. Would investments in equity interest be assessed for impairment under IFRS 9?
 No. Investment in equity is accounted either at Fair Value Through Profit and Loss (FVTPL–in which case all changes in fair value are automatically included in the profit and loss statement) or at Fair Value Through Other Comprehensive Income (FVOCI), in which case changes in fair value are adjusted on the balance sheet.

Q. What’s the expected financial impact of the new impairment framework?
A. It is widely expected that impairment provisioning will increase under IFRS 9, and the biggest impact would be felt during the transition period from IAS 39 to IFRS 9.

The IASB invited preparers of financial statements from major geographical regions to participate in fieldwork to test and discuss its proposals, including the operational challenges for implementation of IFRS 9, the responsiveness of the proposed model compared to IAS 39 and the directional impact on allowance balances. It was estimated that on transition, the impairment provisions under IFRS 9 could be 20-250 percent higher compared to IAS 39. It is expected that the impairment provisions will be highest where the economic forecast is the worst.

The European Banking Authority has published a final Report and final Guidelines on uniform disclosures under the Capital Requirements Regulation regarding the transitional period for mitigating the impact of the introduction of International Financial Reporting Standard 9 (known as IFRS 9) on own funds.

IFRS 9, which applies for accounting periods beginning January 1, 2018, will require the measurement of impairment loss allowances to be based on an expected credit loss accounting model rather than on an incurred loss accounting model. The application of IFRS 9 could lead to a sudden significant increase in expected credit loss provisions and consequently to a sudden decrease in an institution's Common Equity Tier 1 capital. For this reason, institutions that prefer not to recognize the full impact of IFRS 9 (or analogous ECL models) immediately have the option of phasing in implementation of IFRS 9 over a transitional period.

IFRS 9 is being implemented in the EU through a regulation amending the CRR which sets out transitional provisions. The amending Regulation applied directly across the EU from January 1, 2018. A firm that uses the transitional arrangements must publicly disclose its own funds, capital ratios and leverage ratios both with the application of the transitional arrangements and also on a "fully-loaded" basis, i.e., as if the transitional arrangements had not been applied.

The EBA's Guidelines set out a uniform disclosure format to enable institutions to make IFRS 9 (or analogous ECL) disclosures in a consistent and comparable way during the transitional period. The Guidelines will be published on EBA's website, and national regulators must then notify the EBA within two months if they intend to comply with the guidelines. These notifications will also be published on the EBA's website.

View the final Guidelines. - View the CRR IFRS amending Regulation.

The International Financial Reporting Standard 9 (IFRS 9) will fundamentally change accounting practices by requiring firms to consider the impact of possible future events when calculating their capital provisions. With implementation set for 1 January 2018, and parallel runs for the larger institutions scheduled to take place just next year, banks are currently at the most intense stage of preparation for the new regulatory standard.

Due to the start of implementation of the IFRS 9 across the industry, the Center for Financial Professionals spoke to leaders in the field to understand the industry trends and upcoming challenges.

When looking at the disclosure requirements of IFRS 9, what do the new requirements say about a business?

N.W: That’s a question many people are asking, but few answering! As IFRS 9 is both complex and principle-based there is scope for the methodologies to vary between entities. One objective of disclosures is allowing readers of accounts the ability to see the affects of these different methodologies. Enhanced comparability will be one success factors that IFRS 9 disclosures will be measured against.
By its nature IFRS 9 will provide more detailed information about impairment provisions than the current accounting standard, but whether this results in a better understanding of the credit risk businesses are actually facing remains to be seen.

In your opinion, what governance structure is required to support IFRS 9 compliance?

N.W: I don’t think we’re starting with a clean sheet of paper here, but IFRS 9 will put greater demands on governance. A deeper understanding of the component parts of the model and how it all fits together, including with other reporting bases and risk outputs, will be required by those taking decisions. The level of subjectivity around forward looking information also needs to be considered.

What main supervisory issues and concerns should financial institutions be aware of?

G.S: Regulators have a strong interest in promoting a robust and high quality implementation of the IFRS 9 ECL model. That was the reason for the BCBS and the EBA to develop Guidance on the accounting of Expected Credit Losses. The Guidance is about the most prevalent concerns of supervisors related to the IFRS 9 ECL model – to limit the application of ‘practical expedients’ and to pronounce the need to appropriately consider forward looking information.

What potential effects can be professionals expect from the regulatory measures?

G.S: At this point in time, it is too early to predict changes to the prudential framework related to the IFRS 9 implementation. There might be the need for some clarifications on the allocation of IFRS 9 Stage 2 Expected Credit Losses to the regulatory credit risk adjustments, i.e. the assessment whether those provisions can be treated as general credit risk adjustments or not. In the longer term, there might be a need to further develop the current regulatory Expected Loss logic.

How can businesses benefit from having early engagement?

S.C: Early engagement from IFRS 9 programmes, with the impacted business areas is absolutely crucial, whilst most programmes are being run from Group Finance and Group Risk, the introduction of the new accountant standard is going to very specific impacts and may indeed impact on products offered and pricing of those products going forward.  Additionally, there is work and behaviours that can be changed in the BAU environment today, that will impact on the successful role out of the standard in January 2018.

What challenges can FIs expect with the upcoming IFRS 9 implementation?

S.C: The key challenge has to be quantity and quality of data, as well as the ability to implement slick and clean month / quarter end processes. This will be key to understanding and managing the impacts of volatility that will undoubtedly arise, especially In the infancy of the standard being introduced.

In your opinion, how is IFRS 9 looking effect the running of the business?

S.C: In my opinion, the standard will drive the need for consistency of practise across all business areas, it will also drive a culture of proactive rather than reactive credit management.

How can FIs benefit from implementing a good governance structure and embedding into the business?

S.C: FIs having a good governance structure should be a given and this is not particular to IFRS 9. The implementation of the standard does however create the opportunity to review both business and governance processes and to strengthen and re-emphasis where required.

How do you see the role of the accounting and credit risk experts change over the next 6-12 months?

N.W: Increasing amounts of change, unexpected events, and technology will require Accounting Professionals to be agile thinkers and demonstrate an array of skills and knowledge.

G.S: The implementation of the IFRS 9 ECL model requires a close coordination of accounting and credit risk experts in banks. A mutual understanding of both sides’ tasks and deliveries is key for the proper and on-time implementation of IFRS 9. While technical aspects of the model implementation have been in the focus of banks so far, in the future months accounting policy decisions will have to be taken and there will be a rising demand of stakeholders to be informed about the transitional impacts of the new impairment model.

S.C: The role of IFRS 9 professionals will evolve over the next 6 -12 months, as the implementation phase ramps up and business readiness is very much becomes the key to success.  Communication, training to BAU and refinement to front line processes will become more focused over this time.

Neil Wannop, Head of Accounting Development, Lloyds Banking Group

Guido Sopp, Accounting Expert, Austrian Financial Market Authority

Samantha Cunningham, Head of Impairment – IFRS 9 Project, AIB

On 1 January of this year, IFRS 9 became effective for banks. The changes introduced under IFRS 9 include a new approach to the provisioning of loans and receivables that is based on an expected credit loss (ECL) concept. For certain banks, the transition to the new approach could lead to a severe increase in provisions associated with their loan portfolio and, hence, to a severe reduction of their shareholders’ equity base. In principle, an increase of provisions reduces regulatory core capital on a dollar-for-dollar basis. For IRB banks, this principle applies only where provisions are in excess of the regulatory expected loss (EL).

The Basel Committee has developed approaches for transitional arrangements for the impact of ECL provisioning on CET1 capital. The transitional arrangements mainly aim at alleviating the pressure on banks’ CET1 ratios due to unexpected increases in ECL based provisions.

FINMA has followed the Basel Committee’s guidance, and has issued a revised Circular 2013/1 on eligible capital of banks in consultative form that includes a five-year transitional arrangement.

How will the transitional arrangement function in practice?

The proposed transition period is five years long and during that time, percentages of the “new” impairment provisions that a bank recognises as a result of the IFRS 9 adoption will be added back to CET1 capital.

The FINMA hearing for the Circular 2013/1 ended on 31 January 2018, and all changes will be effective as of 1 January 2019 – one year after the international time schedule. Banks can make a one-time decision upon adoption whether they wish to apply the transitional arrangements or not. Institutions that adopt the approach will have to disclose their own funds, capital and leverage ratios both with and without the transitional arrangements to maintain comparability.

How are the transitional adjustments to capital calculated?

Under the transitional arrangements, FINMA proposes to partially reverse the day 1 CET1 impact due to the adoption of ECL provisioning as per below schedule. The impact is determined on an after tax basis. The impact is fixed upon adoption and amortized linearly until the end of 2022 at very latest. The FINMA approach is different to the approach taken in certain other jurisdictions where a dynamic transition method applies. A dynamic transition approach takes changes in ECL during the transition period (e.g., over five years) into consideration. FINMA proposes a semi-annual linear amortisation schedule over five years. In case of an adoption of IFRS 9 on 1 January 2018 the following transitional adjustments to CET 1 apply


FINMA requirements for US-GAAP banks

The proposed FINMA requirements for banks reporting under US-GAAP include transitional arrangements that are equivalent to the IFRS 9 transitional arrangements. In line with the Currently Expected Credit Loss (CECL) implementation schedule under US GAAP, the transitional arrangements end on 31 December 2024 – two years later than for IFRS 9.

What should firms be considering now?

The transitional arrangements provide firms with an extended time period to absorb the day 1 capital impact of an IFRS 9 adoption. In general, loan portfolios with lower credit quality will contribute most to the CET1 impacts of provisioning based on an expected loss concept. For banks in Switzerland, the additional provisions and related CET 1 impacts are expected to be manageable. The applications of the Swiss transitional arrangements is operationally simpler than dynamic approaches implemented in other jurisdictions. Banks need to weigh the complexity of additional disclosure against an increase in CET1. In particular, for benchmarking banks’ CET1 ratios within Switzerland and internationally, it will be important to factor in transitional arrangements applied by the different banks.



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