Omodele Adigun
As most of the banks are bogged down by non-performing loans (NPLs), the commencement of International Financial Reporting Standards (IFRS) 9, supposed to be a solution, may turn out to be additional burden for the banks.
IFRS 9 is an International Financial Reporting Standard (IFRS) promulgated by the International Accounting Standards Board (IASB). It addresses the accounting for financial instruments. It contains three main topics: classification and measurement of financial instruments, impairment of financial assets and hedge accounting. It will replace the earlier IFRS for financial instruments, IAS 39, when it becomes effective in 2018.
“This is expected to put more pressure on banks’ capital as the lenders will need to use part of their profits to make provision for loans that are expected to become non-performing, after making provisions for those that are already non-performing,” said Mr. Adedapo Adeleke, the Director, Banking Supervision Department of the Nigeria Deposit Insurance Corporation (NDIC).
Recall that top 50 debtors were recently said to be owing N5.59 trillion (34 per cent) of total industry credit exposure of N16.29 trillion.
According to Adeleke, banks’ huge exposure to the oil and gas sector has led to higher NPLs following the decline in oil price in 2014.
He added that although the situation had improved, there was a need for the banks to work harder on their capital as higher NPLs had caused erosion of capital and deterioration in their asset quality.
Adeleke explained that with the implementation of the IFRS 9 this January, banks would be required to make provisions for expected loan losses.
The IFRS 9 requires an impairment allowance against the amortised cost of financial assets held at amortised cost or fair value reported in other comprehensive income (FVOCI). The change in this allowance is reported in profit and loss. For most such assets, when the asset is acquired the impairment allowance is measured as the present value of credit losses from default events projected over the next 12 months. The allowance remains based on the expected losses from defaults over the next 12 months unless there is a significant increase in credit risk. If there is a significant increase in credit risk, the allowance is measured as the present value of all credit losses projected for the instrument over its full lifetime. If the credit risk recovers, the allowance can once again be limited to the projected credit losses over the next 12 months.
An exception to the general impairment model applies to financial assets that are credit impaired when they were originally acquired. For these assets, the impairment allowance is always based on the change in projected lifetime credit losses since the asset was acquired.
The new impairment model is intended to address a criticism of the impairment model used during the financial crisis, that it allowed companies to delay recognition of asset impairments. The new model requires recognition of full lifetime losses more quickly, FASB elected to use a different approach to accelerating recognition of impairment losses, requiring full lifetime recognition from the time the asset is acquired, referred to as the “current expected credit losses” or CECL model. Under both IFRS 9 and the FASB model there will be a loss when most assets covered by this guidance are acquired to the extent of the allowance. This loss will be smaller under the IFRS 9 model, due to the 12-month limit.
The NDIC director also stated that the implementation of the IFRS 9 would commence on January 1, 2018, and banks would be required to make provisions for expected loan losses.
This is expected to put more pressure on banks’ capital as the lenders will need to use part of their profits to make provision for loans that are expected to become non-performing, after making provisions for those that are already non-performing, following the deterioration of the lenders’ capital in the past two years due to the recent recess.
IFRS 9 began as a joint project with the Financial Accounting Standards Board (FASB), which promulgates accounting standards in the United States. The boards published a joint discussion paper in March 2008 proposing an eventual goal of reporting all financial instruments at fair value, with all changes in fair value reported in net income (FASB) or profit and loss (IASB). As a result of the financial crisis of 2008, the boards decided to revise their accounting standards for financial instruments to address perceived deficiencies, which were believed to have contributed to the magnitude of the crisis.
The boards disagreed on several important issues, and also took different approaches to developing the new financial instruments standard. FASB attempted to develop a comprehensive standard that would address classification and measurement, impairment and hedge accounting at the same time, and issued an exposure draft of a standard addressing all three components in 2010. In contrast, the IASB attempted to develop the new standard in phases, releasing each component of the new standard separately. In 2009, IASB issued the first portion of IFRS, covering classification and measurement of financial assets. This was intended to replace the asset classification and measurement sections of IAS 39, but not supersede other sections of IAS 39. In 2010, IASB issued another portion of IFRS 9, primarily covering classification and measurement of financial liabilities and also addressing aspects of applying fair value option and bifurcating embedded derivatives.
Certain elements of IFRS 9 as issued were criticised by some key IASB constituents. The model for classifying debt instrument assets permitted only two approaches, fair value with all changes in fair value reported in profit and loss (FVPL), or amortised cost. This represented a significant deviation from FASB decisions, which would also have a category of fair value with certain changes in fair value reported in other comprehensive income (FVOCI). In addition to creating significant divergence with FASB, the lack of a FVOCI category would have been inconsistent with the accounting model being developed by the IASB for insurance contracts. There were also concerns that the criteria for qualifying for the amortised cost category were overly stringent and would force many financial instruments to be reported at fair value even though they could be appropriately accounted for at amortised cost. To address these concerns, IASB issued an exposure draft in 2012 proposing limited amendments to the classification and measurement of financial instruments.
Meanwhile, IASB and FASB worked together to develop a model for impairment of financial assets. IASB issued an exposure draft proposing an impairment model in 2013. FASB decided to propose an alternative impairment model. IASB was also developing its hedge accounting model independently of FASB, and issued that portion of the IFRS 9 standard in 2013. The final IFRS 9 standard, including hedge accounting, impairment, and the amended classification and measurement guidance, was issued on July 24, 2014.
Early evidence on the market reaction to the IFRS 9 in Europe suggests overall a positive response to the IFRS 9, although heterogeneities across countries exist.