New accounting standard governing banks’ loss reporting to come into force in 2018

International Financial Reporting Standard (IFRS) 9 (registration required) was issued by the London-based International Accounting Standards Board (IASB) and forms part of the body’s response to the global financial crisis. Amongst its provisions, it will require firms to account for expected credit losses at the point that they first recognise financial instruments, and to recognise full lifetime expected losses at an earlier stage.

“The reforms introduced by IFRS 9 are much-needed improvements to the reporting of financial instruments and are consistent with requests from the G20, the Financial Stability Board and others for a forward-looking approach to loan-loss provisioning,” said IASB chair Hans Hoogervorst. “The new standard will enhance investor confidence in banks’ balance sheets and the financial system as a whole.”

The IFRS rules are designed as a common global standard to be used by listed companies when compiling their accounts, in order to make them understandable and easy to compare across international boundaries. More than 100 countries currently require or allow the use of IFRS, although the US is a notable exception. The US Generally Accepted Accounting Principles (US GAAP) are overseen by the Financial Accounting Standards Board (FASB).

The new standard is designed to address concerns which emerged following the global financial crisis that banks were unable to account for losses until they were incurred, even when it was apparent to them that they were going to experience those losses. Under IFRS 9, the 'impairment model' used by banks will change from 'incurred loss' to 'expected loss', requiring them to set aside sufficient capital to cover expected losses over the next 12 months. In addition, they will be required to record lifetime expected losses if credit risks increase significantly.

The new impairment model features a three-stage approach to loan loss provisioning, based on ongoing assessment of the level of credit risk, which will apply regardless of the type of asset. Loans will be categorised as performing, underperforming and non-performing, and will be able to move between these categories depending on changes to credit loss expectations.

IFRS 9 also makes changes to classification and measurement, hedge accounting and own credit. Classification of financial assets under the new standard will be based on principles, driven by cash flow characteristics and the business model in which an asset is held, rather than a more rigid rule-based framework. Enhanced disclosures will be required about risk management activity related to hedge accounting, enabling firms to better reflect these activities in their financial statements; while changes in the credit risk of firms' liabilities measured at fair value will no longer be recognised as profits or losses.

The majority of banks questioned by accountancy firm Deloitte as part of a survey, published last month, said that they expected the new rules to increase the amount that banks had to hold to cover loans. Firms are also concerned about the differences between IASB's approach and that of the FASB in the US, which is expected to adopt stricter requirements in its own new standard.

IFRS 9 will need to be endorsed by the EU ahead of its planned implementation for accounting periods beginning on or after 1 January 2018 before it can come into force in the trading bloc. The IASB is encouraging firms to adopt the changes early, particularly those in relation to firms' own credit risks. It plans to establish a 'transition resource group' to assist with the transition to the new impairment requirements.