In the past, credit losses were not recognized until a ‘trigger’ event, such as a default, which led to concerns that provisions were too little, too late. Under IFRS 9, organizations will have to recognize some amount of expected credit losses immediately, and in each period revise expectations of future losses. This could reduce equity considerably. Banks, in particular, need more accurate estimates of future credit losses, and more consistent reporting of performance within and between banks.
Insurers are, arguably, facing the biggest ever change to their financial statements, as IFRS 9 goes to the heart of the insurance business model of matching asset and liability cash flows. Gains and losses on insurance contracts will have to be compared with treatment of gains and losses on matching assets – in order to identify any accounting mismatches.
The new ‘expected credit loss’ model could also cause higher and more volatile reserve levels, with faster recognition of losses if economic conditions deteriorate. Banks that grow their loan books could see lower earnings. With a higher potential cost of capital and lower return on assets, financial institutions may have to rethink portfolios, restructure, divest entities and reposition in different segments, to improve efficiency and revenue.
The new standards require extensive cooperation between credit risk management and accounting, and new disclosure requirements. In order to determine expected credit losses, organizations require complex cash flow and loss calculations. Changes to methodology, technology and controls will be particularly cumbersome for small and medium-sized financial institutions with legacy accounting systems. For larger banks, implementation could cost as much as US$45 million.
The winners will be those that can get ahead of the organizational, procedural, technological and governance changes to create a smoother, lower-cost change program. They will also need a strong communication plan to markets, shareholders and other stakeholders, to optimize credit risk transparency and avoid any negative publicity over reported results.
Danny Clark, KPMG in the UK
Steven Hall, KPMG in the UK
Mahesh Narayanasami, KPMG in the US