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By Tran Dinh Vinh, Partner, Financial Services, KPMG Vietnam
The new financial instruments standard will be a momentous accounting change for banks, as it requires banks to move from an “Incurred Loss” model (IAS 39) to recognising and providing for expected credit losses (ECL).
ECL estimates are generally subject to a high degree of estimation uncertainty. Application is complex for both preparers and audit committees, and demanding for auditors too.
-For preparers and audit committees, it may be difficult to understand how the standards and estimates of ECL apply in detail, and what the implications for the systems and controls will be.
-For auditors, high-quality audit approaches will probably rely on documented, well-controlled, high-quality ECL estimation processes.
-With only months to go until IFRS 9 takes effect, it will take significant effort from auditors to audit the transition to IFRS 9 in 2018, as well as the 2017 financial statement disclosures about the expected impact of the new standards.
Reported credit losses are expected to increase and become more volatile under the expected credit loss model. A recent survey carried out by the European Central Bank reported that the loan loss allowance (the charge that goes through the income statement) could increase by 18 to 30 per cent.
Migration to IFRS 9 would also have a negative initial effect on capital, raising the volatility of earnings and regulatory capital ratios, according to Fitch Ratings.
“Moving to an expected-loss approach would require significant process changes, including greater integration of credit risk management and internal accounting systems,” the ratings agency noted. “Banks would also need more data on how portfolios perform through the credit cycle, and will need to build complex models of expected losses. The transition is likely to be more operationally manageable in sophisticated banking systems, where there is better access to robust data.”
The expected-loss model requires banks to build a new set of credit models and exercise significant judgement to determine loan losses for each reporting period. It has been observed that larger banks mostly implement extensions of their Basel II capital and stress-testing models; for smaller banks who have not yet adopted the advanced Basel capital approach, this is a bigger challenge.
The IFRS 9 implementation also introduces operational risks, as complex models will need to be built, vetted, maintained, and coupled with significant estimations and judgement in order to calculate the new allowance and loan loss numbers.
The challenge is that IFRS 9 is principles-based and does not provide any standard model for expected credit losses. Banks must therefore create their own ECL model. In fact, although the ECL models may be built as extensions of the Basel capital models at some banks, the standards and requirements are different from the capital standards, and therefore another set of books needs to be maintained.
While global banks and regional banks are rushing to prepare for the application of IFRS 9, local banks in Vietnam seem to be ignoring the coming sea-change. The question is whether local banks will be impacted when IFRS 9 becomes effective.
In KPMG’s view, very few local banks who prepare IFRS financial statements have even begun to understand IFRS 9’s requirements and potential impact to their IFRS accounts.
The fact is that local authorities like the Ministry of Finance and the State Bank of Vietnam have not issued regulatory requirements or guidance that forces local banks to apply IFRS 9.
Accordingly, the application of IFRS 9 by 2018 is likely to have no effect on the operations of local banks, except for those who prepare their IFRS accounts.
Without guidance from the regulators, local banks are not forced to study the impact of IFRS 9 or plan for implementation of one of the most challenging accounting standards. However, for some leading banks who want to issue IFRS financial statements to foreign investors and/or partners, the impact is significant, just for the purpose of estimating credit losses and presenting IFRS-compliant figures.
Otherwise, their IFRS accounts will not be prepared in compliance with IFRS 9, and a qualified auditor’s opinion should be expected.
The bank executives, supervisory board, and board members of these banks should engage their auditors to develop plans to apply IFRS 9 sooner rather than later.