IFRS 9 will Introduce a new normal for the banking sector – Jeremy Awori

The relationship between a bank and its customers has changed a great deal in the past few years.

From a time when paperwork and bureaucracy was the order of the day, to a time when technology is now enabling faster, more focused transactions, banking has changed in a way that has been of benefit to the customer.

There is yet another revolution underway, as well. A customer is no longer just an anonymous number. We are nearly at a stage where products and services are tailored to the individual customer. We are close to being able to now create products, price them, and offer them to customers at an individual level.

At the same time, the growing complexity of financial products, and the entire financial industry has meant that regulation has had to follow suit. Even as new products and new ways of selling them have been developed, banking still needs to be as solid, trustworthy and safe as it has always been, perhaps even more so. The lessons the world painfully absorbed in the aftermath of the 2007-08 financial crisis brought home the fact that regulation, as had been carried out prior to this, had not served customers, banks, the economy, and society as well as it should have. In the decade since, this realisation has led to the review of accounting standards to create a more resilient and stable banking sector.  

One of the most significant changes in this arsenal is a new reporting standard that will come into effect on 1st January 2018 across the globe.

International Financial Reporting Standard 9, or IFRS 9, was developed in response to the global financial crisis to help ensure financial institutions recognise and account for risk more prudently. The standard was issued by the International Accounting Standard Board (IASB), for which compliance is a regulatory requirement in the Kenya Companies Act 2015.

IFRS 9 is the accounting standard that deals with accounting for financial instruments such as loans and advances, customer deposits, government securities, cash, borrowings, other debtors and creditors. The standard guides the classification and measurement, impairment and hedging of these financial instruments.

Read: Kenyan financial sector  bracing for impact of new accounting standard

While IFRS 9 may sound quite complicated and esoteric, it is quite, at its core, very simple. The fundamental change introduced by the standard is on recognition of credit risk losses.  Credit risk is the risk that a borrower will default on their contractual obligation to repay a loan. Traditionally, a bank (or any other financial institution offering credit products) has recognised a loan’s risk at the point of default. Under IFRS 9, banks will be expected to provide for things that are expected to happen in future.

IFRS 9 now requires that these institutions recognise this risk at the beginning and during the entire loan’s credit life cycle. In this case, a better understanding of the borrower’s credit profile, industry, the current and expected macroeconomic environment will be important determinants of how to score, measure and price for risk.

Impairment is a measure of risk attributable to the cash flows that an entity may fail to realise in the event of a default. It is a factor of the customers’ probability of default over a specified time horizon, the expected exposure at default and the loss given default for the cash flow not recovered.

Additionally, IFRS 9 introduces a new requirement for calculating credit risk associated with undrawn or unutilized but committed credit facilities reported off-balance sheet exposures. These include, credit and overdraft limits, letters of credit, performance and financial guarantees. Further, the standard introduces a requirement to hold credit allowances for government securities previously not in scope for impairment. This comes in the wake of sovereign risk default witnessed during the 2007-2008 financial crisis.

By analysing, recognising and allocating this risk throughout the life cycle of the loan, financial institutions will be able to tell, at a glance, how much risk their loan books carry, and allocate their resources accordingly.

IFRS 9 substantially changes the rules on provisions for impairment, which will, in turn, mean significant changes for the customer. The one that the consumer will notice the most will be the introduction of cross-product default. Instead of looking at each facility the customer has – credit card, mortgage, personal loan – in isolation, IFRS 9 will mean that we will have one customer, and def