Dubai: Most banks in the GCC have just completed their half yearly financial reporting. However, for accountants and auditors alike, in a sea of accounting change, deadlines seem to be approaching much faster than they anticipated.
The New Year heralds much more than the routine closing for banks. It is also the date of implementation for IFRS 9 — a landslide change in financial instrument accounting.
IFRS 9 is a ubiquitous accounting requirement. For the first time, banks are required to provide for loans and investments, not measured at fair value, based on the expectation of a credit loss rather than the loss being incurred.
This change will impact diverse areas of a bank’s business including accounting, risk management, capital management, regulatory reporting, data collection, governance framework, processes, IT systems, investment decisions, product structuring decisions and hedging decisions.
Even though IFRS 9, on paper, is an accounting requirement, it impacts risk management in a way that many banks did not initially perceive. Some of these banks are fighting an uphill battle to meet the year-end deadlines.
Even from a regulatory perspective, IFRS 9 was a significant change that needed to be addressed. We have observed that Central Banks in many jurisdictions in the GCC have issued specific guidance on IFRS 9 to provide direction to banks regulated by them and bring some elements of comparability on the financial statements.
The guidance from Central Banks in the region (as well as globally) has revolved around a few key themes, including governance, impact on regulatory capital, assessment of key definitions, applicability of Basel Committee guidance, applicability to Sharia Compliant instruments and disclosures.
Governance
IFRS 9, being a principled based standard, provides banks the ability to apply the principle in the manner it is interpreted for internal risk management. The flexibility afforded by the well-intended standard setters could be misused. As with all principle-based guidance, most regulators have mandated banks to set up robust governance structures to mitigate the associated risks.
Impact on regulatory capital
An increase in provisions is expected to reduce capital and consequently result in Banks being required to maintain more regulatory capital. Like with guidance provided by other regulators, we expect to see guidance in the areas relating to the treatment of expected credit losses in the computation of regulatory capital.
Assessment of key definitions
Interestingly, IFRS 9 permits banks to develop their own internal definitions on how to define the key concepts of IFRS 9, eg, definition of default, assessment when a loan demonstrates a significant increase in credit risk. Most regulators have provided country-specific guidance to ensure uniformity in practice by regulated banks.
Applicability of Basel Committee guidance
In December 2015, the Basel Committee for Banking Supervision issued guidance to banks and regulators in relation to credit risk and accounting for expected credit losses. It was suggested that banks adopt the recommendations outlined by the Committee. However, some regional regulators have decided that these must be mandatorily applied by banks under their supervision.
Applicability to Sharia compliant instruments
IFRS 9 prescribes amortised cost as the basis of measurement for instruments that are held to collect contractual cash flows and lending arrangements where contractual cash flows represent repayment of principal and appropriate interest. Sharia compliant instruments, by definition, require a holistic view after considering their substance instead of merely the legal form to meet this criterion. Guidance may be warranted in the treatment of Sharia Compliance instruments.
Disclosures
They are an often underestimated aspect of IFRS 9. We observe that many regulators prescribed minimum disclosures required to be complied. Others provided for additional disclosures to those required by the standard.
In countries where guidance has been issued, banks are concentrating on the above areas to comply with the regulatory requirements of IFRS 9. This has simplified the implementation projects to some extent by providing clarity on the direction and focus.
Given the perceived advantages, we expect other central banks in the region to follow suit and provide guidance on IFRS 9. As banks in the GCC wield their way through the complexities of the new standard, intervention by the regulators in the form of guidance has been well received by banks. Regulatory intervention, which was sometimes seen as bitter medicine, in this instance, is turning out to be a sweet pill.
Bhaskar Sahay is Director, and Nigel Austin D’Souza is Associate Director at KPMG Lower Gulf.
