Domestic institutions in Asia have a long road ahead to meet the January 2018 deadline for reporting under the Financial Instruments rule of IFRS 9 (the 9th International Financial Reporting Standard) – the latest model for classification and impairment of financial instruments and hedge accounting – according to a new survey by Regulation Asia and S&P Global Market Intelligence.
The survey canvassed 189 respondents in 13 countries, focusing on four main issues around the Standard, which adopts a principles-based approach to classifying ﬁnancial assets and liabilities based on business models and cash flow, and provides a single impairment model for recognition of expected credit loss.
Participants expect the new rule to effect a substantial change to the way they approach impairment, speciﬁcally in calculating expected credit loss. One of the largest challenges revolves around collecting data on historical credit behaviour in various portfolios, which tends to be harder on tier 2 and tier 3 banks with a predominantly domestic focus. The remainder of this article presents some of the survey’s key findings.
Preparation and timeline
More than 60 percent of respondents do not expect the implementation deadline in their jurisdiction to be delayed beyond January 2018. Given the new standards are expected to converge to their local equivalent, almost all respondents from China expect an extension in the deadline for IFRS 9 implementation. Close to half of all respondents have begun preparation for IFRS 9 and nearly a third are fully prepared.
But it is far from plain sailing, according to Brad Maclean, head of research at Regulation Asia.
“Over time, the research highlighted institutions both large and small are heavily reliant on external expertise to bridge their own internal knowledge gaps,” he says.
“According to one of the interviewees, firms are caught in a ‘Catch 22’, where building up internal resources and expertise requires external help, but bringing in those external resources itself requires a critical mass of internal expertise.”
IFRS 9 vs. Basel III
Regulation from BCBS (the Basel Committee for Banking Supervision) has been directed towards encouraging banks to use internal models and analysis to develop forward-looking credit models, yet IFRS 9 is pushing banks in the opposite direction. Integrating Basel III models with IFRS 9 and ensuring compatibility in the selection stage is a pressing issue, as bringing together risk and ﬁnance is uncharted territory for banks in the region.
Almost half (43 percent) of respondents are in the process of preparing for model selection.
Banks that have already adopted the internal approach to modelling credit risk under Basel II and Basel III can expect some synergies with IFRS 9. But, in emerging markets, most smaller banks have been using the standardised approach, making IFRS 9 a tougher transition.
The survey found shows data availability is a big concern, predominantly in developed markets like Hong Kong, Singapore and Australia. One bank executive noted the Standard does did not specify how far back in time banks’ should start retrospective application of the model, although a fellow respondent suggested that, compared to Basel III data collection, which involves a larger amount of information culled from branches with uneven collection infrastructures, ﬁnancial asset data is usually kept at the treasury and risk management levels, where data collection is much more robust.
“As implementation progressed and as the deadline draws nearer the research showed a growing frustration among firms – many of which are increasingly losing confidence in their data, especially on corporate lending and SMEs used for producing the ECL,” suggests Maclean.
In China, however, data appears to be less of an issue, with only one respondent there identifying it as one of their top three areas of focus in IFRS 9 preparation. Most respondents have reviewed the availability of historical and trend data to build a forward-looking view of impairment with only minimal to partial gaps in data.
But, as Maclean explains, overall: “Confidence in credit data quality was much lower than expected across developed and emerging markets. Data fragmentation both jurisdictionally across operating subsidiaries was especially challenging for smaller and regional institutions.”
Additional capital requirements are also a challenge, especially in jurisdictions in India and China where ﬁnancial institutions are struggling with provisioning for their large amounts of non-performing assets, as well as capital requirements under Basel III.
According to one respondent, the new rules will shave off roughly 100-150 basis points from their institution’s capital adequacy ratio given an immediate increase in provisioning once the rules have been adopted. Other banks were in the process of reﬁning a number, but expected a drop of between 150-200 basis points in their capital adequacy ratios.
Overall, concludes Michelle Cheong, director, risk services (APAC) at S&P Global Market Intelligence, many institutions still have much to do.
“The top commercial banks in developed markets are well on target in meeting the January 2018 deadline,” she says. “However, many participants are still figuring out (a) what the ‘right’ approach to ECL modelling would be; and (b) how their regional peers are approaching the problem. We expect to see a mad dash to the finish line as the IFRS9 deadline looms”.
To download the survey report please click here