The new accounting standards will have far-reaching consequences for the UAE banking sector
Pijush Kanti Das
Two new ‘big-bang’ global changes are coming to the UAE in 2018. First, is the implementation of Basel III regulatory norms, which will drastically alter the way banks do business. But, a second and a more momentous change is in the offing from January 2018 – the IFRS 9 accounting standard.
The International Accounting Standards Board (IASB) issued the final version of IFRS 9-Financial Instruments which is all set to replace the older IAS 39. In the UAE, IFRS Standards are required both by the UAE Commercial Companies Law No 2 of 2015 and by the listing rules of Nasdaq Dubai, Dubai Financial Services Authority, Dubai Financial Market PJSC, and the Abu Dhabi Securities Exchange.
The new accounting standards will have far-reaching consequences for the entire banking sector, and has forced several banks to prepare for expected credit loss requirements whilst acting to comply to all of its requirements.
Altering the system
The current system, IAS 39, which will be replaced by IFRS9, is a critical accounting standard, prescribing rules for recognising and measuring financial assets, financial liabilities, derivatives and some other non-financial contracts.
After the 2007-08 crisis, which heavily impacted the world, global leaders signalled a need for a move into a more forward looking accounting standard that would enable banks to identify credit losses in advance. That need became more urgent – and thus the IASB decided to replace IAS 39 in its entirety. The new accounting standard, IFRS9, essentially is a move by regulators to avoid repetition of events in the last financial crisis. It will mean that the management of banks can now make more informed judgements than was allowed earlier.
How does IFRS9 work?
The major change that IFRS9 brings to the table is in the impairment of assets. IFRS 9 adopts a single forward-looking expected credit loss (ECL) model that is applicable to all types of financial instruments subject to impairment accounting.
In essence, the new regulation will strongly affect the way in which credit losses are recognised in the balance sheet and profit and loss statement. Under the new regulation, banks are required to move from recognising losses immediately, from an ‘incurred loss’ basis (i.e. when a loss actually happens at a future date) to an ‘expected loss’ basis (i.e. the measured probability of a loss taking place in future on existing loans).
For example, currently if a bank gives a loan to a customer, there are several ways this can turn into a non-performing loan – i.e. the customer could lose his job, or have a serious ailment. This meant that banks would have to immediately react and provide for the loan loss. It also meant that no credit loss was being recognised until the actual credit event took place. However, with the new IFRS9 model, banks will have to anticipate and provide for such losses far in advance.
The impact of IFRS9
As a result, banks will have immediately higher loan loss provisions once the new standard comes into effect. This is thus expected to impact banks’ profits, and in turn capital adequacy ratios, as banks may need additional capital to provide a finance, and will have to factor this into their decision making.
IFRS9 will have also have a significant impact on the future behaviour and the business direction of banks. For instance, banks may avoid more risky loans and increase pricing to customers. The regulation will also impact other financial institutions, such as the insurance sector, which will affect how they classify their assets and investments.
Overall however, this is a good move by regulators for market stability and transparency. It is a change that is forward looking as opposed to reactive, as in the past, banks have been accused of doing too little, too late, as far as recognizing bad assets and providing for them. In contrast, this model is likely to be extremely versatile and will recognise under-performing assets quickly, which was impossible under IAS 39.
Initially, there is a risk that the size and impact of ECL estimates can lead to material misstatements in bank financial statements. Under IFRS 9 there will be important disclosure requirements that will need to be adhered to. Luckily, Banks do have experience with ECL – for regulatory reporting and computation of capital adequacy – but there are some differences. Banks are also actively working with auditors and adapting technology and systems, to ensure they can identify forward-looking losses in accordance to this model.
With this significant regulation set to alter the financial for the better, education on the impact and compliance to these regulations will be especially important for banks. At the Emirates Institute for Banking and Financial Studies (EIBFS), we already hosted an interactive workshop earlier this year, on Basel III and the regional implementation of IFRS9. Going forward, there is no doubt that we will continue to include this system into our new curriculums for our students and trainees.
The writer is senior trainer at Emirates Institute for Banking and Financial Studies.