Supervisory expectations on the implementation of IFRS 9

As one of the responses to the financial crisis requested by the G20 leaders, the new accounting standard, International Financial Reporting Standard 9 (IFRS 9) Financial Instruments, introduces major changes, mainly for the accounting of financial assets. By introducing the expected credit loss (ECL) model, IFRS 9 addresses the fact that credit loss provisions should be recognised in a timely fashion, because it was found that they were generally perceived to be recognised “too little, too late” in the context of the crisis.

The new accounting requirements are more closely aligned with risk management. The role of judgement in the implementation and subsequent application of IFRS 9 is significantly augmented, requiring the development of new robust and resilient internal controls and governance arrangements. Given that accounting results are used as a basis for the calculation of own funds and capital requirements and also form the basis of economic capital calculations by the bank, prudential supervisors have a keen and legitimate interest in the quality and rigour of the implementation of IFRS 9. Taking into account the importance of such high-quality implementation, ECB Banking Supervision has launched a two-year thematic review scrutinising banks’ preparedness for the high-quality implementation of IFRS 9. ECB Banking Supervision has included this project in its supervisory priorities for 2016 and 2017, with the focus on the changes to provisioning practices.

The thematic review addresses three key objectives:

1. evaluation of banks’ level of preparedness for the introduction of IFRS 9;
2. assessment of the potential impact of IFRS 9 on credit institutions’ provisioning practices in terms of qualitative characteristics and quantitative impact;
3. high-quality implementation of IFRS 9 that contributes to the level playing field in terms of effective capital requirements.

To gain a comprehensive picture of the banking sector, the scope of the thematic review includes all significant institutions at the highest level of consolidation in the euro area that apply IFRS.

While IFRS 9 will only be applicable with effect from 1 January 2018, banks should already make adequate preparations for the robust implementation of the new standard well in advance of its entry into force. In their preparation, banks should ensure the quality of the underlying data and models used for the calculation of ECLs by allowing sufficient time for testing and for parallel runs of IAS 39 and IFRS 9 impairment calculations that cover substantial parts of their portfolios. This will enable them to provide reliable results and capital ratios immediately after IFRS 9 is applied without the need for significant post-implementation changes in 2018.

ECB Banking Supervision launched the thematic review for more than 100 significant institutions in December 2016. Given the implementation timeline for IFRS 9, this fieldwork and data collection is taking place in the first quarter of 2017 and will be followed by continuous monitoring and evaluation of industry-wide progress with implementation. ECB Banking Supervision expects the results of the thematic review to form part of the supervisory dialogue in 2017 to prepare for the proper, robust and consistent implementation of IFRS 9 and its provisioning policies by 1 January 2018.

To undertake the thematic review, ECB Banking Supervision is assessing whether and to what extent banks take into account the supervisory principles established by the Basel guidance on credit risk and accounting for expected credit losses, which were incorporated in the European Banking Authority’s consultation paper on this subject. In addition to this guidance, the ECB is taking into consideration emerging best practices and implementation issues on the basis of discussions with institutions, auditors and consultants. The ECB encourages the development of proper policies and governance for the provisioning process and highlights the importance of timeliness and transparency in implementation processes. It also encourages banks to leverage, to the extent possible, the existing data, processes and methodologies used for prudential purposes.