Are You Underestimating IFRS9?

IFRS 9 represents a convergence between accounting and regulatory standards and introduces a range of complexities and uncertainties that need careful consideration and planning

By: Darryl J Ivan, National Lead Risk Management SAS Canada, P Eng, MBA

The clock is ticking. On January 1, 2018, the new international financial reporting standard, IFRS 9, created in response to the 2007 – 2008 financial crisis, comes into effect, and must be implemented by organizations at the start of their fiscal year following that date.

Given that the fiscal year end for Canadian D-SIBs ends October 31st, OSFI has mandated that Canada’s largest banks commence reporting under IFRS 9 November 1st 2017.  As a result, the major Canadian banks have the dubious distinction of being the first to report under the new standard, and the world will be watching.

No pressure.

Unfortunately, many are underestimating the effort.   IFRS9 is a complex journey that is changing the way firms account for their provisioning activities, manage risk and their data. The new standard contains three critical components, including:

1.      Classification & Measurement: defines which valuation approach should be used for which balance sheet items;

2.      Hedge Accounting: redefines requirements that allow the use of hedge accounting;  

3.      Impairment Calculations for Credit Losses:  re-defines the expected credit loss (ECL) calculation used to determine the required allowance amount for qualified financial instruments.

This final change is perhaps the most complex and most significant piece of work as it implies moving from incurred loss (IAS39) to expected credit loss (IFRS9). The new standard requires entities to account for expected credit losses when financial instruments are first booked and to recognize lifetime expected losses on a timely basis where credit deterioration has been identified. IFRS noted that the delayed recognition of credit losses on loans and other financial instruments was identified as a weakness in then existing accounting standards. It was deemed significant enough that the IFRS created a transition resource group to assist institutions in the transition to the new requirements.

Not just a financial reporting issue:

IFRS 9 is not simply a financial reporting issue.  The impairment calculations for credit loss under IFRS 9  represents a convergence between accounting and regulatory standards introducing a number of organizational complexities and uncertainties that will create implementation and maintenance challenges.  These include but are not limited to:

·New credit modelling approaches to accommodate point in time macro-economic analysis and lifetime expected credit
loss (ECL) calculations;

·Additional data requirements including loan level data;

·Potentially significant impact to income and by extension capital as well as the potential to introduce significant volatility to earnings, all of which are unsettling to board, management and shareholders as it impacts equity valuation;

·The need to create a flexible exploration environment that facilitates dynamic testing and exploration of parameters and macro scenarios prior to production;

·Accurate and timely reporting of ECL calculations;

·Coordination of work efforts between key internal stakeholder groups such as Risk Management, Accounting and Treasury;

·Emphasis on governance and oversight, requiring a disciplined and controlled operating environment that provides access controls, transparency and auditability.

These factors add up to increased demand not only on Accounting and Risk Management staff, but on the IT organization responsible for data management and maintenance of a fairly complex ecosystem. Expected credit loss calculations require a lot of data and computing power and rigorous processes and robust models that have to stand up to regulator and auditor scrutiny. There is also the risk with these new principles-based standards that regulators will change their interpretation over time, so every assumption and decision must be thoroughly documented and managed, creating a massive burden of governance and controls. All this at a time when banks are looking to streamline costs, create efficiencies in spite of elevated regulatory and investor scrutiny.

Asking the important questions

When developing an IFRS 9 approach to address these challenges we have found that the most advanced organizations have actively engaged key internal stakeholders and have thoroughly thought through understanding and planning for the following:

1. Will the solution be able to dynamically test the impact of changes to staging allocation rules as well as other important inputs related to the accounting standard?

2. Will the solution be robust enough to calculate expected credit loss down to the loan level with confidence?

3. Is the IFRS 9 platform, or its components,reusable in other critical areas such as stress testing, Basel model deployment or economic capital?

4. Will the solution have adequate controls and the ability to provide transparency/audit trails that hold up against rigorous examination from regulators and auditors, while minimizing manual intervention in the workflow and in data aggregation and output?

5. How can IT accelerate speed to execution of IFRS 9 to allow the commencement of early testing/parallel runs, preferably with existing infrastructure?

6. How can the organization manage all of the data challenges, including sourcing, quality, aggregation and traceability/lineage of data?

7. What are the ongoing maintenance costs and operational risks beyond the initial deployment of an IFRS 9 solution? Is it scalable; can it easily move from relatively simple models to more complex models, and from segment level analysis to loan level analysis?

8. How will the product be supported, and what is the vendor roadmap for it? Do you have a partner, or a relationship with an experienced vendor, who can provide reasonably priced, deep support beyond the initial deployment of the IFRS 9 solution?   

The risk attached to getting these components wrong is  significant. Not only will it cause regulatory consequences, a poor solution can be more expensive to operate, and can cause increased volatility in earnings. However, with a good set of technology and processes, organizations will be in a better position to manage and stand up to scrutiny from regulators, auditors, investors, and, since Canada will be first to implement IFRS 9, its peers around the world.

The transition to IFRS 9 won't be simple, it will have a substantial financial impact on banks and involve significant implementation challenges but with preparation, and a knowledgeable partner, it can be made less painful. To achieve this goal banks will need substantial support from technology. SAS's white paper, Navigating the route to IFRS 9 compliance, enumerates best practices, and its IFRS 9 solution addresses the challenges, including: data capture, tools for model development, risk engines for model deployment and execution, orchestration and process controls, functions for management and regulatory reporting and preparing accounting posting journals.

The Upside

It’s not all doom and gloom. IFRS 9 is a great opportunity to not only improve the risk and finance integration process beyond stress testing and into BAU (Business as Usual). It is another process that banks can utilize to drive better discipline by facilitating better risk/return metrics and hence a truer cost of credit in pricing at origination. The IFRS9 journey provides firms with an opportunity to modernize the risk infrastructure, break the silo between risk and finance and drive more transparency in the business.

To learn more about turning IFRS9 from a challenge to an opportunity contact me +1 (416) 307-5025/

About the Author:

Darryl Ivan is National Lead Risk Management SAS Canada. In his role Darryl works with financial institutions to advise on Financial and Risk Management solutions. With over 15 years of risk management experience, Darryl has extensive knowledge designing and implementing risk management capabilities in the financial services sector.

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