Helping developing countries take accounting standards to the next level

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IFRS 9—an accounting standard that became effective in January 2018—has changed how credit losses are recognized in financial statements. By replacing an incurred credit loss approach with an expected credit loss (ECL) approach, it requires banks to recognize losses earlier in the credit cycle, since the origination phase (stage 1), and to increase provisioning—also incorporating forward-looking information—when credit risk rises (stage 2, or Significant Increase of Credit Risk [SICR]).  

COVID-19 is the first real test to IFRS 9. Countries that have already implemented the accounting standard are confronted with two main questions: How does the pandemic affect the significant increase of credit risk? And how can banks estimate ECL in such an uncertain environment?  

Countries are also concerned about IFRS 9 procyclicality—or its tendency to amplify the effect of the downturn resulting from the cyclical sensitivity of credit risk parameters, which are used to estimate expected credit losses, and from the shifts of exposures between stages.  

A recent World Bank paper provides a set of high-level policy recommendations for countries that are in the process or willing to transition to IFRS 9.  The paper, Accounting Provisioning Under the Expected Credit Loss Framework: IFRS 9 in Emerging Markets and Developing Economies—A Set of Policy Recommendations, is based on jurisdictions’ reflections on the challenges they faced and remedies they used when implementing IFRS 9. It also includes lessons learned during COVID-19.

In addition, the paper presents the results of a survey conducted in the second quarter of 2020 in 91 countries as well as case studies focused on the experiences of six different countries.  


Challenges with implementation  

Modeling risk, low data quality and availability, and limited staff capacity are the top challenges faced by supervisors while implementing IFRS 9 (Figure 1), according to the survey. Especially when these issues overlap, supervisors’ capacity to adequately review banks’ models, data inputs, and adequacy of loan loss provisioning can be limited.  


FIGURE 1 - Supervisors’ Challenges in Implementation of IFRS 9 
Supervisors? Challenges in Implementation of IFRS 9
Note: Percentages represent share of respondents who selected that option; the respondents could select all options that apply.

To address these challenges, several supervisors issued guidelines on IFRS 9 implementation clarifying that COVID-19-related relief measures such as public guarantees or payment moratoriums—granted either by public authorities or by banks on a voluntary basis—should not automatically result in exposures moving to stage 2.  

Many supervisors also performed quantitative impact assessments of ECL on banks’ balance sheets, investigated banks’ preparedness for IFRS 9 implementation via bilateral meetings, questionnaires, and on-site visits, as well as conducted workshops and training sessions for capacity building of banks. Most of them introduced transitional arrangements to spread the IFRS 9 impact on banks’ capital over a longer period, implemented parallel runs with previous accounting standards, or kept prudential backstops, such as a minimum floor on provisioning.  


Policy recommendations 

Because challenges with the implementation of IFRS 9 can be substantial, prudential supervisors should be prepared before embarking on the journey of transitioning to expected credit loss. During the preparatory phase, they should formulate a comprehensive plan, strategizing the transition to IFRS 9 and inform banks’ boards and senior management about the significance of the challenges.  

Where possible, supervisors should use expert judgement to define the boundaries for IFRS 9 application. On one hand, imposing IFRS only on banks of a certain size adheres to the proportionality principle, but it might excessively fragment the accounting and reporting framework. On the other hand, requiring all banks to apply IFRS might lead small and medium-sized credit institutions to outsource the ECL calculation, which would leave them without understanding the underlying model and with limited capacity to manage the associated risks. Supervisors should always require a good understanding of the ECL model by banks as well as rigorous governance and internal control processes for assessing external vendors.  

Supervisors should also invest in credit-risk modeling capacity, both in terms of human resources and information technology tools. Supervisory technology (SupTech) solutions can be useful in addressing challenges related to data collection and ECL modeling. The goal is to ensure that banks’ methods for determining accounting allowances lead to an appropriate and comprehensive measurement of ECL. Those supervisors with budget constraints can build up capacity on the ECL model through online training platforms and technical assistance.  

During the implementation and monitoring phases, it is important to set clear, timely, and comprehensive supervisory expectations on the ECL framework and ensure broad consistency between credit classification criteria and the IFRS staging process. Supervisors should also strike a balance between flexibility and oversight on entry and exit criteria to and from stages 2 (SICR) and 3 (‘impaired loans’, which are part of non-performing loans) and should consider prudential backstops on provisioning. To mitigate procyclicality, they should require banks, when the economic recovery accelerate, to replenish capital buffers, that can be released in time of stress. The use of transitional arrangements can also be beneficial, as suggested by the experience of different countries. 

All in all, a sound policy decision on whether and when to implement IFRS 9 should be based on a broad assessment of the preconditions that ought to be in place. They include maturity and quality of external audits, robust governance- and risk-management arrangements in banks, and credit risk modeling expertise in banks and supervisory staff. With all these aspects in place, emerging markets and developing economies will be better prepared to take their accounting standards to the next level. 


Ezio Caruso

Senior Financial Sector Specialist

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