The new accounting rules requiring banks to take upfront charges against possible losses through the full life of a loan promise damaging pro-cyclicality.
We are all going to be hearing a lot more this year about IFRS 9, requiring banks to recognise expected loan losses even before borrowers miss a single interest or principal repayment. This is a big change.
Over the past few years, Kenyan banks have been preparing for the implementation of International Financial Reporting Standard 9, a new accounting principle for financial instruments that becomes effective this month.
IFRS 9 will change the way banks classify and measure financial liabilities, introduce a three-stage model for impairments (stage three being nonperforming), and reform hedge accounting.
In preparing for the new principle, banks have dedicated most of their efforts to technical and methodological issues—in particular, how to incorporate forward-looking assumptions and macroeconomic scenarios into their existing models and approaches.
IFRS 9 requires an entity to recognise a financial asset or a financial liability in its statement of financial position when it becomes party to the contractual provisions of the instrument.
At initial recognition, an entity measures a financial asset or a financial liability at its fair value plus or minus, in the case of a financial asset or a financial liability not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or the financial liability.
I believe banks face a number of strategic and business challenges in adapting to the new environment under IFRS 9. Addressing these challenges will require fundamental changes to their business model and affect areas as diverse as treasury, IT, accounting, and risk management.
Banks that start to plan for these changes now will have a considerable advantage over those that have yet to consider the full implications of IFRS 9 for their business.
To help banks get ahead, I have identified strategic actions in five areas: portfolio strategy, commercial policies, credit management, deal origination, and people management.
IFRS 9 will prompt banks to reconsider their appetite for credit risk and their overall risk appetite framework, and to introduce mechanisms to discourage credit origination for clients, sectors, and durations that appear too risky and expensive in light of the new standard.
For example, if banks consider project finance to be subject to volatile cyclical behavior, they may decide to limit new business development in such deals.
To react quickly and effectively to any issues that arise, they should also adjust the limits for project finance, review their credit strategy to ensure that new origination in this area is confined to sub segments that remain attractive, and create a framework for delegated authority to ensure that their credit decisions are consistent with their overall strategy for this asset class.
IFRS 9 will reduce profitability margins, especially for medium- and long-term exposures, because of the capital consumption induced by higher provisioning levels for stage two.