The International Accounting Standards Board (IASB), has outlined the new international standard on financial assets accounting, IFRS 9. This will be a revised update of the former IAS 39 regulation, motivated by the delayed recognition of credit losses on loans in the 2008 financial crisis. IFRS9 will be fully implemented on January 1st 2018.
IAS 39 is currently a range of requirements and guidelines put in place for recognition and measurements for financial assets. This means there are a set of rules that have to be followed when inputting financial data for an organisation’s assets. It is a framework for how public companies prepare and disclose their financial statements.
The current framework IAS 39 was referred to as ‘under-providing’ due to the fact that losses did not have to be recognised at the time of lending and were only accounted for when they occurred. IFRS 9 forces the recognition of expected future losses at the point of lending, leading to a more accurate profit and loss account.
On the 1st January 2018, current credit portfolios will have to be reassessed under the new regulations. Portfolios will undergo three phases in order to improve the performance of financial statements from the past.
Phase One: Classification and Measurement
Principle-based approach for the classification of financial assets to replace the existing rule-based requirements.
Phase Two: Asset Impairment
IASB has introduced a new, expected loss impairment model.
Contingent liabilities (estimated losses) on financial assets will be noted in the financial statement. It should also take into consideration the contingent assets as well (potential gains) but no matter how large, these do not need to be recorded.
The international framework IFRS 9 introduces a series of reporting requirements; write-offs and recoveries, explanation of asset book values, breakdown by risk grade, and reconciliation of allowance accounts. Lenders are also required to have a simulation reporting environment and an answer to management reporting needs.
As a part of the impairment methodology, loans are assigned to one of three stages: Performing, Underperforming and Nonperforming. Performing loans are those where no difference in risk is observed between the time of origination and the present day. Underperforming loans are those which display an indicator of default, without any confirmed default. Non-performing loans show evidence of default i.e. 90 days past due.
Phase Three: Hedge Accounting
Hedge Accounting will now be more closely aligned with financial risk and will be managed as such.
Furthermore, as a result of these changes, users of the financial statements will be provided with better information about risk management and the effect of hedge accounting on the financial statements.
What This Means for Us
Whilst the models to be used for IFRS9 can be adapted from the existing models used to calculate Probability of Default (PD), Loss Given Default (LGD) and Exposure At Default (EAD), the requirements to apply an Effective Interest Rate (EIR) to the potential timing of the default requires a huge increase in the number of calculations required. This is especially true for organisations with multiple portfolios, who will want to run many simulations using different macro-economic scenarios due to the sizeable effect on the P&L account.
Dylan Chambers, Marketing Manager, GDS Link