IFRS 9: credit institutions’ progress with implementation
The introduction of International Financial Reporting Standard 9 (IFRS 9) for financial instruments brings substantial changes to the accounting regime for credit institutions. The changes involve both the classification/measurement of financial instruments and the impairment calculation, which now takes forward-looking information into account and requires a more timely recognition of credit losses. The requirements of the new accounting standard are viewed as an implementation challenge for banks. ECB Banking Supervision therefore decided in 2016 to launch a thematic review on IFRS 9 as part of its supervisory priorities, in order to assess institutions’ preparedness and foster high quality and consistent implementation.
The conduct of the thematic review showed that the institutions in scope had achieved different levels of progress by the end of the first quarter of 2017; indeed, a number of them had not been sufficiently prepared for the assessment. The institutions were therefore divided into two batches on the basis of their progress in the implementation of the new accounting standard.
- The first batch of institutions under the direct supervision of the ECB had been fully assessed by the Joint Supervisory Teams by 31 March 2017 and individual letters with supervisory recommendations were issued and discussed with them. The results for this first batch of institutions were published on the ECB Banking Supervision website in November 2017.
- The second batch of institutions, for which the assessment had to be deferred to the second half of 2017, received a warning letter from the ECB in the first quarter of the year, urging them to increase their efforts in order to implement IFRS 9 in a timely manner and to high quality standards. This supervisory action clearly prompted institutions to intensify their work on IFRS 9 and, as a consequence, supervisors were able to complete the assessment of the second batch by 30 November 2017. In line with the supervisory practice followed for the first batch of institutions, supervisory dialogues were held with the second-batch institutions as well, to communicate findings and recommendations.
Overall, the thematic review has contributed to an increased awareness of the challenges posed by implementing the standard.
Both first and second-batch institutions are doing relatively well on aspects related to the implementation of the definition of default and business model assessment. The main areas for improvement relate to the implementation of validation and back-testing, the incorporation of forward-looking information and the measurement of expected credit losses.
Overall, supervisors noted that the second batch of institutions has only partially managed to catch up with those institutions at a more advanced stage of implementation. As with the first batch, particularly small entities continued to lag behind larger ones. The most significant differences in the findings for the first and second batches of institutions can be observed in governance, validation and back-testing, and the calculation of expected credit losses.
Regarding the quantitative impact of implementing IFRS 9, institutions in the second batch estimated an average negative fully-loaded impact on their Common Equity Tier 1 (CET1) ratio of 59 basis points, which is higher than the average negative impact (40 basis points) estimated by those assessed in the first phase. For this calculation only those institutions experiencing a negative impact were considered. If institutions with a positive impact were also taken into account, this would lower the average negative impact to 44 basis points for second-batch institutions and 36 basis points for first-batch institutions. This outcome is in line with initial expectations, given that in the second batch more institutions using the standardised approach were assessed and the impact was expected to be higher for them than for institutions using an internal ratings-based (IRB) approach. This expectation is based on the fact that IRB institutions have to deduct from CET1 any shortfall in accounting provisions with respect to the expected loss calculated for regulatory purposes; the existence of such a shortfall would absorb, to an extent corresponding to the shortfall, the impact on CET1 of any increase in accounting provisions.
As a next step, ECB Banking Supervision will monitor progress in the implementation of the remedial actions that institutions were asked to put in place to rectify the shortcomings identified in the course of the thematic review.
Another focus for supervisors is the analysis of the first-time application impacts of IFRS 9, including the change in exposures and in provisions and their allocation. The IFRS 9 transitional arrangements introduced by European Union co-legislators to the prudential framework will also be followed up. These transitional arrangements are intended to mitigate the potential negative impact on institutions’ CET1 capital resulting from the transition to IFRS 9 impairment requirements. In this context, ECB Banking Supervision will closely monitor credit institutions’ application of the phasing-in rules as this might have a relevant impact on the capital ratios of some institutions during the transition period. It should be noted that the transitional add-back to CET1 capital can be applied only to provisions arising from the move to an expected credit loss model under IFRS 9 and not to provisions already within the scope of IAS 39 requirements. The correct application of this rule will prevent credit institutions from benefiting unduly from the application of the prudential transitional arrangements. ECB Banking Supervision will continue its dialogue with external auditors, following the principles set out in the European Banking Authority Guidelines (EBA/GL/2016/05).