Relaxations in IFRS 9 gives UAE banks flexibility to support creditors
Dubai: In a recent move the Central Bank of UAE (CBUAE) has issued a new requirement for all banks to apply a prudential filter to International Financial Reporting Standards 9’s (IFRS 9) expected credit loss (ECL) provisions to minimize provision requirements at a time banks are hard pressed for liquidity and funding.
“The prudential filter aims to minimize the effect of IFRS 9 provisions on regulatory capital, in view of expected volatility due to the COVID-19 crisis. Any increase in the provisioning compared to 31 December 2019 will be partially added back to regulatory capital,” the CBUAE said in a recent statement.
According to the proposed transitional arrangements IFRS 9 provisions will be gradually phased-in during a five-year period, ending 31 December 2024.
Introducing transitional arrangements for the accounting of expected credit losses at banks will delay banks’ creation of provisioning buffers to absorb potential future credit losses, a credit negative. Nonetheless, the transitional arrangements give banks greater flexibility to support borrowers facing temporary liquidity issues.
More flexibility for banks
Analysts said the change in approach to IFRS 9 is in sync with the dramatic economic consequences of COVID-19 outbreak on the economy and the banking sector.
“Introducing transitional arrangements for the accounting of expected credit losses at banks will delay banks’ creation of provisioning buffers to absorb potential future credit losses, a credit negative. Nonetheless, the transitional arrangements give banks greater flexibility to support borrowers facing temporary liquidity issues,” said Mik Kabeya, an analyst at credit rating agency Moody’s.
According to KPMG, concerns have been voiced about the effect of the relatively new IFRS 9 standard and expected losses (ECLs) reporting, which may force banks to take earlier provisions against bad loans.
“Several assumptions and linkages underlying the way ECLs have been implemented to date may no longer hold in the current environment; banks should not continue to apply their existing ECL methodology mechanically,” said Emilio Pera, Partner Head of Audit KPMG Lower Gulf.
On 27 March 2020, The International Accounting Standards Board (IASB) issued guidance on accounting for expected credit losses applying IFRS 9 Financial Instruments in light of the uncertainty resulting from the pandemic. It sets out that in assessing forecast conditions, consideration should be given both to the effects of Covid-19 and significant government support measures being undertaken.
Several assumptions and linkages underlying the way expected credit losses (ECLs) have been implemented to date may no longer hold in the current environment; banks should not continue to apply their existing ECL methodology mechanically.
According to KPMG, it is likely to be difficult currently to incorporate the specific effects of Covid-19 and government support measures on a reasonable and supportable basis. However, changes in economic conditions should be reflected in macroeconomic scenarios applied by entities and in their weightings.
Analysts believe that in the current environment, IFRS 9 and the associated disclosures can provide much-needed transparency to users of financial statements.
“Several prudential and securities regulators have published guidance commenting on the application of IFRS 9 in the current environment, including CBUAE, and IASB encourages entities whose regulators have issued guidance to consider that guidance,” said Pera.
According to KPMG, under the current uncertain economic environment, lending institutions will need to analyze any such arrangements (temporary relaxation in IFRS 9 reporting standards) carefully to determine the appropriate accounting, i.e. they will need to assess whether there has been a change in the contractual terms of a financial instrument and, if so, whether it leads to a de-recognition of gain or loss, or a re-measurement of its amortized cost; and whether the arrangement indicates a significant increase in credit risk or a credit impairment, or results in a partial write-off of the loan.
While offering a temporary relaxation in reporting standards, the CBUAE expects banks to maintain transparency in their accounting on the impact of COVID-19.
“The central bank requires banks to disclose the effect of the application of the transitional arrangement in their financial statements and Pillar 3 reports, which will provide investors a way to consistently adjust and compare financial statements across the years,” said Kabeya.
UAE banks adopted the International Financial Reporting Standards (IFRS 9) from January 1, 2018.
Effective for annual periods beginning on or after January 1, 2018, IFRS 9 set out how banks should classify and measure financial assets and financial liabilities. Its scope includes the recognition of impairment. In the standard that preceded IFRS 9, the “incurred loss” framework required banks to recognise credit losses only when evidence of a loss was apparent.
Under IFRS 9’s expected credit loss (ECL) impairment framework, banks are required to recognise ECLs at all times, taking into account past events, current conditions and forecast information, and to update the amount of ECLs recognised at each reporting date to reflect changes in an asset’s credit risk.
It is a more forward-looking approach than its predecessor and will result in more timely recognition of credit losses and a likely increase in NPLs. At a time of the global economy is facing a pandemic crisis and economic crisis, the strict application of IFRS 9 and ECL reporting looks unviable and regulators are supportive of the current requirements.
Stages loss recognition
Under the ECL framework impairment of loans are recognised under three stages.
Stage 1: When a loan is originated or purchased, ECLs resulting from default events that are possible within the next 12 months are recognised (12-month ECL) and a loss allowance is established.
Stage 2: If a loan’s credit risk has increased significantly since initial recognition and is not considered low, lifetime ECLs are recognised. The calculation of interest revenue is the same as for Stage 1.
Stage 3: If the loan’s credit risk increases to the point where it is considered credit-impaired, interest revenue is calculated based on the loan’s amortised cost (that is, the gross carrying amount less the loss allowance). Lifetime ECLs are recognised, as in Stage 2. Twelve-month versus lifetime expected credit losses ECLs reflect management’s expectations of shortfalls in the collection of contractual cash flows.