The largest six global accounting networks release a paper summarising expectations regarding implementation of IFRS 9 impairment requirements for systemically important banks.
The Global Public Policy Committee (GPPC), a global forum of representatives of the six largest international accounting networks, released The Implementation of IFRS 9 Impairment Requirement by Banks (the paper). The paper is addressed to the audit committees of systemically important financial institutions and represents the consensus views of the GPPC members regarding key matters for the implementation of the impairment requirements of IFRS 9.
Summary of the paper
The introduction of new requirements for the accounting of expected credit losses (ECL) in IFRS 9 Financial Instruments will be a significant change to the financial reporting of banks when required in 2018. Given the importance of banks in the global capital markets and the wider economy, the effective implementation of the new standard has the potential to benefit many. Conversely, a low-quality implementation based on approaches that are not fit for purpose has the risk of undermining confidence in the financial results of banks. Accordingly, the paper is designed to help audit committees evaluate management’s progress toward a high quality implementation of the impairment requirements of IFRS 9. To this end, the paper is organised into two main sections:
1 Areas of focus for those charged with governance
The first section of the paper addresses the following key areas:
The importance of strong governance and controls surrounding ECL models and processes – the paper highlights that areas of the finance function will provide key inputs to the ECL estimation process (such as forecasts of future macroeconomic conditions) and will be subject to auditor scrutiny in a new way.
Considerations regarding sophistication and proportionality – the paper notes that the GPPC networks believe that there is no one size fits all approach and do not expect the same level of sophistication of implementation across all institutions and all portfolios. However, the GPPC networks do expect the sophistication of implementation to be proportionate to the complexity and materiality of the portfolio and material and complex portfolios will require a sophisticated approach.
Key issues on transition – the paper acknowledges that IFRS 9 builds upon existing credit practices, but may also require the development of new processes specifically for the estimation of ECLs pursuant to IFRS 9.
Ten questions those charged with governance may wish to discuss – the paper provides questions that audit committees may wish to discuss with their management team to help assess the quality of management’s implementation of IFRS 9’s impairment requirements.
2 Modeling principles
The second section of the paper addresses and discusses the following key areas:
ECL methodologies – the overall framework for estimating 12-month and lifetime ECLs under IFRS 9
Default – there may be different definitions of default currently used by financial institutions – legal definitions, internally used credit definitions, and regulatory definitions, amongst others. This area discusses how banks might define default for purposes of IFRS 9 and deal with these divergent definitions
Probability of default – both 12-month probabilities of default (PDs) and lifetime PDs may be calculated for IFRS 9 and their relationship to regulatory definitions.
Exposure – how exposure at default (EAD) and the period of exposure may be calculated for IFRS 9 and their relationship to regulatory definitions
Loss Given Default (LGD) – how LGD may be calculated for IFRS 9, specifically focusing on the incorporation of forward-looking information, and its relationship to regulatory definitions.
Discounting – the interaction of the use of the effective interest rate (EIR) and discounting under IFRS 9, in particular questioning whether the current use of approximations of the EIR under IAS 39 will remain appropriate for IFRS 9 ECL estimation purposes.
Staging assessment – techniques and approaches institutions may use in approaching the staging assessment for IFRS 9.
Forward-looking information – how banks may incorporate different forward-looking information into its IFRS 9 ECL estimates, including the consideration of multiple forward looking scenarios.
Each of the above areas within the modeling principles section present the discussion in terms of a sophisticated approach that may be appropriate for more complex or material institutions or portfolios; a simpler approach that may be appropriate for less complex or material institutions or portfolios; and also approaches that would be inconsistent with a high-quality implementation of IFRS 9.
We expect views of regulators, auditors and preparers to evolve over time, and this paper is by no means the last word on what will constitute a high quality IFRS 9 ECL estimation process. The paper is not authoritative and its primary audience is systemically important financial institutions. However, we believe the paper is an important document that should be considered by all banks as they endeavour to implement IFRS 9. Similarly, banks should also consider the guidance in the Basel Committee on Banking Supervision’s Guidance on Credit Risk and Accounting for Expected Credit Losses.
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