The European Systemic Risk Board (ESRB) has published a report on the financial stability implications of the International Financial Reporting Standard 9 (IFRS 9). The report has been prepared following a request by the European Parliament. The report analyses two main aspects of IFRS 9 from a macro-prudential angle with a focus on banks:

  • the new approach to the classification and measurement of financial assets; and
  • the new expected credit loss (ECL) approach for measuring impairment allowances.

The ESRB concludes that the classification of financial assets under IFRS 9 will, in principle, be clearer and sounder than under its predecessor and should not generally lead to a significant increase in the use of fair value by EU banks, at least at the aggregate level.

In addition, the ESRB highlights in the last section of the report the areas identified as deserving attention from the perspective of financial stability:

  • usage of fair value accounting. The introduction of IFRS 9 does not itself justify a reconsideration of prior decisions regarding the regulatory treatment of some fair value changes. However, particular attention may be needed during the post-implementation period to assets that under the new standard may meet the conditions for measurement at amortised cost while being eligible for the liquidity coverage ratio, and therefore, presumably sellable during periods of liquidity stress;
  • modelling risk. The report elaborates on the importance of avoiding models with unnecessary complexity, providing regulatory guidance on key discretionary choices, guaranteeing the quality and effectiveness of the information provided through disclosures, and making sure that the external auditing and enforcement of IFRS 9 meets the ambitious goals of the new standard;
  • lending behaviour. Banks may adjust the interest rate charged on loans in anticipation of the new impairment allowances. While such re-pricing may well improve efficiency through a more adequate pricing of risk, it could also alter the composition of credit portfolios and its evolution throughout the business cycle. Depending on the competition in certain loan markets, such a response has the potential to shift credit risk to entities not subject to IFRS 9, including some beyond the regulatory perimeter;
  • pro-cyclicality. If soundly implemented, the expected credit loss approach to IFRS 9 is expected to contribute to financial stability by introducing greater levels of transparency and a more timely and decisive recognition of credit losses. In addition, the ESRB sets out policies to address pro-cyclicality in the event of a sudden tightening of bank’s capital constraints; and
  • the standardised approach (SA) and less sophisticated banks. The adoption of ECL by SA banks implies the need for further investigation of their regulatory capital regime, especially in the terms of the treatment of provisions and its consistency with the calibration of the capital requirements.

The report is accompanied by ESRB Occasional Paper No. 12 Assessing the cyclical implications of IFRS 9 – a recursive model. This occasional paper describes a model for assessing different approaches to the accounting of credit impairment losses. In particular, it compares the impact of a crisis on banks assuming four such different approaches, including the current approach in International Accounting Standard 39 (incurred losses) and the solutions adopted under IFRS 9 and in the United States respectively.

View ESRB reports on financial stability implications of IFRS 9, 17 July 2017