Blog 2016 01
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Aptivaa is launching a blog series to explain key aspects of IFRS 9, focusing on impairment modeling and the challenges banks face in its implementation. IFRS 9 introduces a forward-looking expected loss approach, replacing the incurred loss model from IAS 39, and emphasizes the need for collaboration between risk and finance teams to avoid issues during implementation. The standard will take effect for annual periods beginning on or after January 1, 2018, necessitating a minimum of two years for banks to adapt their systems and processes.
Blog 2016 01
- 1. In the backdrop of the buzz that IFRS 9 has generated in the banking industry, and to demystify IFRS 9 principles,Aptivaa is pleased to launch a series of blogs to apprise readers of some of the key aspects related mostly to impairment modeling, for compliance with the new accounting standards, as well as to have a conversation with the readers about the challenges that banks are facing in their implementation efforts. On 24 July 2014, IASB issued the fourth and final version of its new accounting standard – IFRS 9 Financial Instruments, which replaces most of the rule-based standards of IAS 39 with principle- based guidance. IFRS 9 is built on a logical, single classification and measurement approach for financial assets that reflects the business model in which they are managed and their cash flow characteristics. The fundamental shift from IAS 39 to IFRS 9 standards is “Incurred LossApproach” to “Forward-looking Expected Loss Approach” for impairment assessment. In the past, accountants were not comfortable with accounting based on “expected” outcome unless they have “sufficient proof” to believe so; due to which loan loss provisioning was 'too little, too late'. The fundamental responsibility of accounting is to ensure “True and accurate Representation” of accounts in P&L statement. Given this background, IFRS 9isafundamentalshiftinmindset. The Standard also includes an improved hedge accounting model to improve the link between the economics of risk management with its accounting treatment. From IAS 39 to IFRS 9 ISSUE 01 Contact: info@aptivaa.com | www.linkedin.com/company/aptivaaWebsite: www.aptivaa.com | Page 1
- 2. IFRS 9 principle comprises of three structured components: Asuccessful implementation of IFRS 9 is predicated on the successful and the close coordination between Risk and Finance teams within a bank and the proverbial 'breaking of the silos' is paramount. Banks that approach an implementation in silos is likely to run into considerable problems at a later stage. Many banks in emerging markets have asset allocations that are relatively non-complex and not subject to dynamic changes. This simplifies identification of business models for Asset classification, but the same reasons call for extensive credit risk modelling efforts for impairment calculations. Hence, Impairment modeling is one of the core areas where banks need to focus. IFRS 9 will be effective for annual periods beginning on or after January 1, 2018, subject to endorsement in certain territories; therefore considering the complexity of changes in systems, processes, and data requirements, Banks would require minimum of two years of implementation and a parallel run to ensure the readiness for 2018. In the coming week, we will be discussing the Building blocks of impairment modeling. The post will aim to broadly cover the understanding of core components of ECL measurement and challenges related to each component in detail. This space aims to answer your queries pertaining to IFRS 9 principles. In case, you have any queries pertaining to IFRS 9 which you wish to discuss, do leave your comments. As a part of IFRS 9 series, we will be touching upon the following topics in the coming weeks Ÿ BCBS expectations of high quality implementation of IFRS 9 standards Ÿ The loss rate approach and how is it different from a PD/LGD approach Ÿ The master rating scale and its applicability Ÿ Distinction between PD and historical default rate Ÿ Distinction betweenTTC PD and PITPD Ÿ Identifying different stages of impairment model Ÿ PD calibration methodology and its significance in/for ECLmeasurement Ÿ Characteristics of LGD parameter in Risk Models and its distinction from expected cash shortfall Ÿ EAD and its use, and how is it different from ‘current outstanding’exposure Ÿ Lifetime expected credit loss and why it is not a simple multiplication of lifetime PD and LGD Ÿ Key requirements for validation and governance framework, and many other key areas related to impairment modeling We expect that these discussions, with feedback from our clients and associates, will help our readers in demystifying various principles of IFRS 9 impairment modeling. Introduction of new measurement category: ‘Fair Value through other comprehensive Income’(FVOCI) ‘Tainting rule’ has ceased to exist in IFRS 9 – i.e., sales of ‘held to maturity’ assets under IAS 39 before maturity jeopardize amortized cost accounting for entire portfolio Classificationofinstrumentsarenowbasedon- Ÿ Entity’s Business Model Ÿ Contractual Cash flow characteristics test (SPPI) Classification & Measurement01 COMPONENT ECL model is applicable for instruments classified under Amortized Cost and FVOCI (debt instruments) category Recognizes 12-month loss allowance at initial recognition and lifetime loss allowances on significantincreaseincreditrisk IFRS 9 replaces IAS 39 ‘Incurred Loss’Model with new Forward looking Expected Credit Loss (ECL) model Requires incorporation of forward-looking information in ECLestimates Introduction of new hedge accounting model The 80-125% hedge effectiveness testing ratio range is replaced by an objectives- based test that focuses on the economic relationship Simplified hedge accounting rules to reflect moreaccuratelyhowanentitymanagesitsrisk More designations of groups of items as the hedged items are possible under new rules Impairment 02 COMPONENT Hedge Accounting 03 COMPONENT Contact: info@aptivaa.com | www.linkedin.com/company/aptivaaWebsite: www.aptivaa.com | Page 2