IFRS 9 – ECL
IFRS 9 and Basel 4 for Banks
The objective of the reporting standards IFRS 9 and Basel 4 is to ensure that banks keep sufficient regulatory capital and provisions for credit losses, by changing the way in which they are calculated.
IFRS 9 and IFRS 17 for Insurance Contracts
IFRS 9 and IFRS 17 will be implemented to ensure that asset liability management for insurers will be more clearly aligned.
IFRS 9 Financial Instruments
In response to the global financial crisis in 2008, the International Accounting Standards Board finalised the publication of IFRS 9 Financial Instruments in July 2014. The current IFRS 9 replaces any previous versions that were in progress since 2008.
IFRS 9 introduced a logical model for classification and measurement. It is a single, forward-looking ‘expected loss’ impairment model and a reformed approach to hedge accounting. Unlike IAS 39, IFRS 9 does not depend solely on past experience.
Probability of Default and Loss Given Default are key parameters required for the estimation of expected credit loss.
The PD forecasts for IFRS9 impairment calculation need to be point-in-time, conditional on macroeconomic variables, and forecasted over many years.
Actuaries possess the technical expertise required to model these parameters, using financial and statistical modeling to look into the future and assess the likelihood of an undesirable event occurring, the timing of such an event, and the amount of the loss.
Banks will need to report on an IFRS 9 basis from 01 January 2018.
In 2021, the insurance industry must adopt IFRS 9 Financial Instruments. This will adopt an alignment of standards for reporting assets and liabilities.
The following changes were made by IFRS 9:
Phases of the Project
- Classification and measurement
- Impairment, and
- Hedge accounting
The main area of interest from a modelling perspective is impairment
Classification and measurement
The way in which financial assets and liabilities are accounted for in a financial statement is known as Classification. IFRS 9 specifies how to classify assets according to cash flows and the business model the asset is held in.
With existing accounting standards for insurance contracts, companies are not required to report in a standard way, making it difficult to compare insurance contracts. The aim of the new requirements is to have a single, principle-based model which will enable easy comparison amongst financial instruments.
In the current accounting standards, there is no requirement to identify credit losses at the introduction of a financial instrument. This would create credit losses that were identified only later on in a policy, which is considered a weakness. The new standards require recognition of expected credit losses at the time of introduction of financial instruments, thereby lowering the threshold for full lifetime expected losses.
There is an interim stage added to the impairment model, at the point where there might be a significant credit deterioration. Initially the provision is the 12-month expected loss. The interim stage recognises significant credit deterioration, if there is one, and allocates a provision of a lifetime expected loss. Third stage will recognise objective evidence of impairment, and allocate the provision needed.
The IFRS 9 requires transparency via enhanced disclosures about risk management activity. The new model introduced by IFRS 9 drastically changes hedge accounting, by aligning the accounting with risk management activities, thereby enabling institutions to better reflect risk management activities in their financial statements. These changes will enable users of the financial statements to have access to better information regarding risk management activities and the effect of hedge accounting on the financial statements; which will enable investors to get a better understanding of risk management activities and to assess the severity, frequency and uncertainty of future cash flows.
- Actuaries Institute. (n.d.). Banking Regulatory Update Basel 4 and IFRS 9. Retrieved from Actuaries Institute: http://www.actuaries.asn.au/Library/Events/Insights/2016/INS160630Nagarajan.pdf
- IFRS. (n.d.). IFRS 9 Financial Instruments. Retrieved from IFRS: http://www.ifrs.org/Current-Projects/IASB-Projects/Financial-Instruments-A-Replacement-of-IAS-39-Financial-Instruments-Recognitio/Pages/Financial-Instruments-Replacement-of-IAS-39.aspx
- S&P Global Market Intelligence. (n.d.). IFRS 9 Regulation Insights. Retrieved from Regulation Asia: http://www.regulationasia.com/sites/default/files/downloads/IFRS9SurveyRA.pdf
- (Accenture Consulting, n.d.) (IFRS, n.d.) (IFRS, n.d.) (S&P Global Market Intelligence, n.d.)Navigating Compliance: Are You Ready