Dubai: The implementation International Financial Reporting Standards 9 (IFRS 9) from January 2018, a game changer for banks across the world, is unlikely to result in any massive spike in provisions for banks in the Gulf Cooperation Council (GCC) region, according to bankers and analysts.
The new regulation strongly affects the way credit losses are recognised in the profit and loss (P&L) statement. While impairments are currently based on ‘incurred losses’, IFRS 9 introduces an approach based on future expectations, namely expected losses (EL).
The main impact on banks is the need to recognise EL for all financial products, and at individual and grouped-asset levels. Banks will have to update their calculation at each reporting date to reflect changes in the credit quality of their assets. This will significantly increase the number and frequency of impairment quantifications that must be undertaken and the amount of data that must be processed for such purpose.
But for GCC banks, the additional provisioning burden may not pose significant impact on balance sheets. Banks operating GCC countries may face lower loan loss requirements under IFRS 9 rules because these may well be less onerous than current provisioning requirements, according to Fitch Ratings.
“Under IFRS 9, when a loan is first made or acquired, it is assessed for expected losses over an initial 12-month period and an upfront provision is booked automatically, triggering an immediate capital hit. Positively for most GCC banks, the impact of having to write provisions up front will not be that significant because they are already used to booking general reserves when they extend new loans,” said Eric DuPont, Senior Director Financial Institutions at Fitch Ratings said in a recent note.
IFRS 9 is going to be a genuine paradigm shift for banks worldwide. This is not an issue that affects only the finance or risk functions. The ripple effect of IFRS 9 will be felt across organisations. Higher provisioning will force banks to review their capital requirements. Product mixes and business models will also need to be evaluated.
“IFRS 9 is a change that will significantly impact banks across the globe. In fact, the biggest accounting development for banks today is likely to be IFRS 9, as it will significantly impact balance sheets, accounting systems and processes,” said Yusuf Hassan, Partner, Risk Consulting at KPMG.
Despite the relatively low impact on provisioning, switching to IFRS9 will be challenging for GCC banks. The absence of a long default history in many countries, coupled with difficulties in correctly assessing collateral values and time frames for realisations, makes it particularly tricky to assess expected loan losses. Banks are working closely with their auditors and adapting technology and systems to make sure they can plug data gaps to model forward-looking losses.
When IFRS9 comes into force in January 2018, GCC banks will be required to recognise and provide for expected credit losses on loans. They currently report under IAS39, which means they write provisions when losses are incurred, and face supplemental additional requirements set by local regulators. Across the GCC banks keep relatively high level of general reserves to protect banks against unexpected losses.
A 1 per cent general reserve on all on-balance-sheet loans is required in Kuwait (plus a 0.5 per cent reserve on off-balance-sheet exposures) and Saudi Arabia, while Oman differentiates by type of loan, applying a higher 2 per cent reserve for higher-risk personal loans. In UAE, banks need to hold reserves equivalent to at least 1.5 per cent of weighted credit risks — this generally works out at below 1 per cent of gross loans because facilities extended to public sector entities are 0 per cent risk weighted — while Bahrain and Qatar adopt a more bespoke approach.
Among the GCC regulators the Kuwaiti regulator is particularly tough and loan loss coverage ratios for the Kuwaiti banks are ample, around 260 per cent. This is due to the Central Bank of Kuwait’s unique requirement for additional case-by-case ‘precautionary’ provisions, which depends on the outcome of portfolio reviews.
Analysts say, in general, regulators across GCC may not be willing to allow the write-back of existing reserves because they are keen for banks to preserve existing buffers to protect themselves against unexpected losses.
“We think the toughest supervisors, such as those in Kuwait and Saudi Arabia, are likely to be reluctant to allow banks to cut back on their current high levels of loan loss reserves once IFRS9 is enforced. A compromise between auditors and regulators may have to be reached,” said DuPont.
