New accounting rule brings change for fincos
Sagicor Group Jamaica reported last month that its commercial banking subsidiary grew assets by two per cent in the three-month period ending March, relative to the previous quarter, tempered by a near half-billion dollar writedown linked to the adoption of a new accounting rule that took effect on January 1.
Accountants have been warning that the impacts from the adoption of IFRS 9 would be substantial for financial companies, with Sagicor Bank being one of the first tangible demonstrations.
But some professionals within the field said this week that the change also presents an opportunity for companies within the financial sector, noting that while they might be faced with higher provisioning costs, it will allow them to revise their business models to reduce risk.
International Financial Reporting Standards, IFRS, are set by the IFRS Foundation and the International Accounting Standards Board, the IASB. They aim to make accounts comparable across international borders while facilitating international shareholding and trade.
The new IFRS 9 rethinks the accounting for financial instruments. It is the result of revisions following the global financial crisis of 2008 and the criticism that IAS 39 was difficult to understand, apply and interpret.
The current loss model under IAS 39 only allows impairment provisions for losses occurring at the reporting date. The new impairment rules are forward-looking, which will have major implications for preparers of financial statements, industry members state.
Sagicor Bank's $441-million writedown was for 'expected credit losses', or ECL. Sagicor Group also reported ECL impacts on its investment banking subsidiary but did not quantify them. Still, at 14.5 per cent and 14.4 per cent, respectively, both subsidiaries outperformed the regulatory 10 per cent capital-to-risk-weighted assets ratio in the March quarter.
Accounting professionals Dawkins Brown and Alok Jain describe IFRS 9 as the biggest accounting change since IFRS was adopted in 2002.
Financial instruments falling within the scope of ECL - the 'expected credit loss' model - include financial assets measured at amortised cost; financial assets mandatorily measured at fair value through other comprehensive income, or FVOCI; loan commitments that are not measured at fair value through profit and loss, or FVPL, when there is a present obligation to extend credit; financial guarantee contracts that are within the scope of IFRS 9 that are not measured at FVPL; and lease and trade receivables.
Jain, a partner at Price-waterhouseCoopers Jamaica (PwC), says loan or receivable provisions are now made on the basis of expected, rather than incurred or realised loan losses. Under IAS 39, provisions were made only after loans were classified as non-performing.
"IFRS 9 has a forward-looking impairment model, requiring banks to set aside funds, by way of provisioning, in anticipation of future loan losses. This means that a loan does not necessarily have to become non-performing for a provision to be taken. A provision can be due to a change in a risk factor, such as forecasted downturn in the economy or drought for an agricultural sector borrower, for example," he said.
Changes in fair value
IFRS 9 is based on the concept that financial assets should be classified and measured at fair value, with changes in fair value recognised in profit and loss as they arise, unless restrictive criteria are met for classifying and measuring the asset at either amortised cost or fair value through other comprehensive income, he added.
"While IFRS 9 is simpler than IAS 39, the simplicity comes at a price - greater volatility in profit or loss. Under the old IAS 39, the default measurement for non-trading assets was FVOCI while under IFRS 9, the default is FVPL," said the PwC partner.
Brown, the managing partner at Crowe Horwath Jamaica, says that with the movement of impairment of trade receivables from an incurred-loss model to an expected-loss model, "bad debt provisions are likely to increase as provisions are made against expected losses and not just when there is evidence of impairment".
He noted that regulatory capital is expected to be impacted.
"Impairment acts as a drag on capital adequacy, with a rise in impairment inevitably depleting the capital adequacy of banks and affecting profitability," Brown explained.
"Under IFRS 9, a financial asset is credit-impaired when one or more events have occurred that have a detrimental impact on the expected future cash flows of the financial asset. It includes observable data that has come to the attention of the holder of a financial asset," he added.
Brown outlined three main reasons why higher impairment costs are expected for banks.
First, banks will provide for the lifetime expected credit loss of exposures that have declined in creditworthiness but not yet incurred a loss.
Second, IFRS 9 requires banks to recognise future losses immediately. "Banks will need to develop effective credit management skills and be able to manage problem accounts," he asserted.
And third, banks are expected to develop probability-weighted loss estimates against a range of macroeconomic scenarios. "This is likely to result in a more conservative view of impairment in many cases," the accountant said.
PwC's Jain noted that the credit modelling required is an opportunity for financial institutions to revisit their business models, saying banks in particular will need to reconsider their product portfolio and risk management.
It will likely "lead to tightening of credit evaluation and appraisal processes for granting loans," said the accountant.
"Arising from more sophisticated and granular credit-risk assessment models and processes, banks will be better able to distinguish between good credits and bad credits. Riskier customers will find it harder or costlier to access credit. Conversely, good customers could possibly see their borrowing rates going down," he said.