The new accounting standard IFRS 9 is effective from 1 January 2018 and delivers a host of reporting changes, including how organisations should account for financial instruments like cash and cash equivalents, trade receivables, loans and other financial assets.
The way in which financial institutions account for credit losses, for example, has implications for provisioning and hence directly impacts their profitability and reported bottom line. It is not surprising, therefore, that many organisations are paying close attention to how the new reporting standard impacts their growth outlook.
The role of economists is also shifting. Previously, in-house economists may have focused on devising economic outlook information for strategy formulation, trading and investment decisions or internal capital planning purposes, for example. With the advent of IFRS 9, economists’ views are not only a desired, but required input into credit modelling and gain further relevance as a newly audited component under IFRS 9.
According to the standard, to arrive at an estimate of expected credit loss (ECL), an organisation should use all reasonable and supportable information available at the reporting date about past events, current conditions and forecasts of future economic conditions. Furthermore, the ECL estimate should be probability-weighted and unbiased, based on the inclusion of probability-weighted scenario views of possible future economic conditions. As a result, the measurement of credit losses can be particularly sensitive to changes in macroeconomic forecasts. As the level of judgement required in making the ECL calculation rises, it becomes ever more important that the inputs, assumptions and techniques used in estimating the ECL are reasonable and supportable.
Due to the combination of econometric modelling and expert judgment usually required to derive economic forecasts, economists generally spend a considerable amount of time deliberating:
These decisions have a significant influence on the degree of confidence that can be placed on the forward-looking information devised by economists and may still require frequent updating, especially in more volatile emerging markets like South Africa.
Once these forward-looking views are ready for incorporation into the ECL estimate, they must still be suitably linked to relevant credit parameters, where economists would place emphasis on the following modelling decisions:
Since the choice of variables, modelling methodology and model validation can significantly influence the size of the forward-looking adjustment to the ECL estimate, strong governance and accountability are essential in supporting the implementation of the forward-looking component under IFRS 9.
Economists play a key role in helping organisations move from an incurred- to expected view of credit losses. Furthermore, their role extends beyond devising appropriate forward-looking views, as they are also key in facilitating the implementation of econometrically robust models that link economic information and credit parameters.
All entities adopting IFRS 9 must consider how the changing reporting requirements shift the scope of work for the economists who advise them. Because economists now play a role in helping organisations estimate ECLs under IFRS 9, they carry an additional responsibility to uphold the highest possible standards of economic modelling that combine insights from econometrics as well as a deep understanding of the mechanics of economic activity, including their implications for credit risk. In an environment of volatile and complex economic conditions, economists face the tall order of formulating clearly defined views of possible future economic outcomes, as well as to link these reliably to portfolio risks. While this may prove difficult, it can help organisations better manage the effects of changing economic conditions, especially the implications of worsening economic prospects.
Visit our IFRS – Financial instruments page for a range of tools and resources in relation to IFRS 9.
© 2017 KPMG Services (Pty) Limited, a South Africa private company and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.