Quality and clarity of explanations is key
So far, banks’ implementation disclosures for IFRS 9 have ranged from an overall impact estimate with a brief explanation to detailed transition reporting. But the spotlight will be shining ever harder on banks as the year progresses towards the release of the first 2018 interim reports and the market looks for more detailed disclosures from more banks.
The quality and clarity of the explanations is key, and it will take time and effort to get everyone comfortable with the level of detail you’ll need to provide. Time is running out fast, as even your interims will require some demanding disclosures.
This is a significant challenge that banks have to rise to. It won’t be straightforward – the changes to the carrying value of loan books are arguably the biggest since mark-to-market was introduced as a concept. Certainly, it’s the biggest change to the valuation process I’ve seen in my 30 years advising banks.
And let’s not forget that the impairment figure is often the largest single number where management judgement is applied in the whole of the accounts.
I feel that some have been under-estimating the scale of the task. It’s a wholesale change – it’s not just a case of adding on an expected loss figure to the old amount. It’s much more fundamental than that. And while the accounting model is more complex, it will also result in regulatory capital impacts as well as a need to transform processes and controls.
Ever-growing numbers of banks have published an impact number. But if the 2017 accounts were about the disclosure of the size of the impact, the 2018 accounts – and, indeed, the quarterly and/or half-year updates – will be the first time that the impact is actually recognised. Banks will want to include clear and comprehensive disclosures to properly articulate the impacts to the users of the accounts.
It will require a different level of communication from what we’ve seen in the past. The clarity of the disclosures will be critically important.
We have to remember that explaining the mechanisms behind expected losses will be much more complex than the short credit discussions that used to appear in the notes. Articulating it succinctly, in language that retail investors as well as professional investors and analysts can understand, will not be easy.
It won’t be easy internally within the bank, either. There are sure to be long discussions with boards and audit committees. Their first question is frequently ‘What is the percentage impact on provisions?’ But from there, the conversation will need to move to having an explanation of how the number is arrived at and key underlying judgements.
Analysts will be benchmarking and comparing. And they’ll be looking for detailed explanations. If your bank seems to be an outlier compared to its peers, you’ll need to ask some searching questions: Why are we out of line? Are our valuation models right? What can we learn by benchmarking ourselves against other banks?
Benchmarking will be easier between banks that operate only within one country or market – but considerably harder between global, cross-border banks.
These internal discussions need to happen at the same time as you’re refining your measurements. I doubt that any bank is confident that they’ve got it absolutely right the first time. That’s part of the reason why it’s difficult to be too expansive in the pre-implementation disclosures.
The process must begin now of honing the measurements and the calculations in order to give more robust updates at interim reporting dates. It’s at the interims stage that I would expect disclosures to move up a gear – though even then, we’re likely to see some variance in detail. Most likely, it won’t be until the 2018 accounts are published that we have truly full disclosures.
Even then, however, I would anticipate that it might take a year or two for best practice to really settle and emerge. We saw this in our own industry with long-form auditor reports, which are now published in a wide number of jurisdictions. In the first couple of years, there was quite a lot of variation between different audit firms – but over time reports have become more aligned.
One of the reasons for the difficulty is that it remains a tremendous challenge to benchmark impairment allowances. The market has developed models for valuing derivatives, for example, but these depend on feeding in market data from bond yield curves. But there is no such market data against which to benchmark impairment models.
It wouldn’t surprise me if regulators take a keen interest in variations between banks and ask for models to be stress-tested under ‘what would happen if…?’-type scenarios.
Some areas will be fascinating to watch. The amount of provisions will be impacted by off-balance sheet items such as credit card commitments under the new standard, and different entities may have different judgements on the expected period of exposure to credit losses. But how far will banks go in separating out impairments by product types or customer categories? The number of loan age and type categories used for collective provisioning already varied widely under the old standard – but will we see new and more categories under the new standard? I expect we will.
These new analyses could mean that comparability with the past will be difficult, though we will have better comparability over time for the same entity.
All this comes at a time when we appear to be entering a period of rising interest rates, after a decade or more of near-zero rates in Western economies. This makes it essential that impairment models have econometric sensitivities built in.
The good news is that the work and calculations banks need to do for the revenue and leasing standards are likely to be less onerous.
With revenue, indications to date are that the new revenue standard doesn’t have the same pervasive and material impact on banks’ financial statements – it’s often a case of making sure the appropriate disclosures are made in the accounts. Big conglomerates with non-banking arms such as insurance or asset management, however, will have more work to do, with potentially greater impacts, and some potentially complex disclosures.
Similarly, communications so far indicate that the impacts of the leasing standard are relatively self-contained, although again the disclosure requirements are more complex and those banks where leasing is a significant part of the business will have more to do.
Most bank CFOs I speak to regard IFRSs 15 and 16 as technicalities that give them limited concerns. It is IFRS 9 that is really creating the pressure – and is something that CFOs everywhere know they just have to get right.
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