Assessing the impact of IFRS 9 - not looking too onerous for banks or is it too early to tell?
03 April 2017
By Attul Karir
As banks prepare to implement the new forward looking model for loan loss provisioning (IFRS 9 in January 2018), market commentary is suggesting that although loan loss provisions will increase by 18% on average and up to 30% for some, the impact on capital will be fairly small (a reduction of 59 bps on CET 1) and therefore less severe than initially feared. It is important to note that this commentary is based on a sample of banks responding to surveys and the statistical findings come with significant caveats. Banks are still finalising their IFRS 9 models and it will only be later this year that more reliable predictions can be made on the capital impact of IFRS 9.
There are obvious reasons to expect an increase in the level of provisioning required when comparing IAS 39, a backward looking approach to loan loss provisioning, to IFRS 9, which is an ‘expected credit loss’ model. Fundamentally, the ability to consider forward looking information in determining the accounting estimate results in the recognition of lifetime losses earlier in the lifecycle of a loan portfolio.
A number of surveys have taken place where worldwide banks have provided their expectations on what the impact will be for their own balance sheets. Moody’s survey of 185 worldwide banks claims that almost 40% of banks expect less than 0.1% impact on CET 1, which is significantly below the EBA’s average of 0.59%.
These surveys are based on internal guesstimates which may not necessarily reflect the reality, particularly given the early stage of implementation that many of the newer challenger banks are typically at. From what I have seen, a number of these banks have provided best estimates based on a high-level view which is not necessarily model driven.
The complexity of IFRS 9 has highlighted a number of areas which can dramatically impact provisioning requirements. In conducting due diligence on short term lenders, I have found that the potential impact of IFRS 9 on revolving credit (including short term loans) is particularly pronounced. These lenders are grappling with a number of issues, including for example how they measure the behavioural life of a credit card or how they deal with off-balance sheet undrawn commitments. These components of IFRS 9 models are unexpectedly driving up provisioning requirements.
Based on what I have seen, there is some time to go before banks can provide a firm view on the impact of IFRS 9. The impact on provisioning and capital will depend on not only the quality of loans that banks hold but also the product type and how provisions are currently determined under IAS 39. The impact of IFRS 9 is likely to be more pronounced (on a relative basis) for loans that are revolving or facilities where there is an undrawn amount.
More broadly speaking, even if the impact of IFRS 9 on capital levels is muted, there are a number of regulatory factors which could increase the level of capital that banks need to hold, for instance the Basel Committee on Banking Supervision’s proposed floor on RWA calculations at 75% of standardised RWAs.
At our PwC European Bank Restructuring conference last week, there was a view that whilst regulation cannot be reversed, the industry is anxiously hoping for a pause to be taken with the new rules and requirements. There were concerns expressed that changes to RWA modelling may become disconnected with the actual riskiness of the underlying loans.
How has all of this impacted the valuation of banks?
We have seen multiples for UK banks rebound to where they were just before the EU referendum. There is an element of recovery following the unexpected outcome of the referendum and the sentiment that IFRS 9 may not be as punitive as initially feared. Despite the recent rebound, I would caution that there are other regulatory changes in the pipeline that could reverse this trend.
In my next blog I will explore how the transition to IFRS 9 in January 2018 could impact the valuation multiples of banks as we approach the implementation date for this new standard.