Osama Shakhatreh, Assurance Partner, Ernst & Young Jordan: Viewpoint

Viewpoint: Osama Shakhatreh

The final version of International Financial Reporting Standard (IFRS) 9 – with its mandatory date of implementation from January 1, 2018 – is one of the most complex accounting standards issued by the International Accounting Standards Board, and one with serious impact on banks worldwide. IFRS 9 has been under development since the time of the 2008 global financial crisis, and is a result of the pressure and criticism to the current accounting standards for late recognition of impairment losses, and mismatches between revenue recognition and the recording of impairment losses.

The most important part of IFRS 9 for banks in Jordan is the new forward-looking expected credit loss (ECL) impairment methodology for their loan books and other debt-security portfolios, which are currently measured at amortised cost. The ECL model requires banks to calculate and book provisions for loan losses on all debt instruments, including credit commitments not yet disbursed, based on expectations of default over the life of the instrument. Banks will be obligated to invest and develop their IT platforms, data warehouses, probabilities of default models and develop ECL engines to enable them to measure their forward-looking expectations.

The standard also instructs banks to begin calculating ECL from the first instance of credit commitment, raising the debatable question of how sensible it is to book losses on day one of granting a credit commitment. What the standard aims to address is that no credit decision is based on zero risk, but rather is a result of a calculated risk. Financial assets like short-term placements between banks, as well as government and corporate bonds, will now also be subject to ECL calculation. The main issue arising from this is that banks will now be required to book provisions for their locally issued government bonds, mainly foreign currency bonds, whereas previously this was never the case.

While there may be some similarities between the ECL model and the risk-management systems currently used by banks, these systems will now need to be aligned with IFRS 9 prerequisites, the IT strategic view of the banks and how they serve their needs over the long term.

More importantly, the output of this new model is not just a mere internal report for management use and the regulator, but the results will feed into the financial reporting process to calculate and book credit losses, which will then be published in banks’ annual financial reports.

From the perspective of Jordan’s banks, this will demand higher involvement from the respective boards of directors in steering the implementation of IFRS 9, as well as the increased responsibilities of a board’s oversight over financial reporting and governance of the provisioning process.

Moreover, with the credit risk now factoring into a loan’s provisioning from the first instance, this will likely have an impact on the pricing policies currently set by Jordanian banks. Banks are required to disclose the expected negative impact on their total equities from the implementation of IFRS9 in their 2017 financial statements. In summary, banks should not underestimate the financial cost of IFRS 9 implementation, the amount of effort required and the needed involvement of senior management to be fully compliant with IFRS 9 by January 1, 2018. Parallel to this, guidance is required from central banks as the ECL model overlaps with the current local provisioning rules issued by several of the central banks regionally.

Staging the criteria for moving assets from the good loan book to the intermediate loan book, and what constitutes a significant increase in credit risk, will need to be clarified by central banks in order for banks to use consistent guidelines for ECL calculation within the financial services industry.