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How new accounting rules can help instil discipline in sector

The new standard will require borrowers to be extremely disciplined in loan repayment and prudent in borrowing. FILE PHOTO | NMG
The new standard will require borrowers to be extremely disciplined in loan repayment and prudent in borrowing. FILE PHOTO | NMG 

The new International Financial Reporting Standard (IFRS) 9 replaces International Accounting Standard (IAS) 39 with respect to the methodology used in providing for uncertainties in economic benefits of financial assets, loans or debts issued by financial institutions (impairment provisions on financial instruments).

The new standard took effect on January 1, 2018 and affects any financial statements prepared after that date.

The public is also duly advised that the implementation of the new standard takes immediate effect and all affected entities will be expected to prepare compliant financial reports going forward.

The new impairment requirements in IFRS 9 are based on an Expected Credit Loss (ECL) model and replaces the IAS 39 incurred loss model.

ECL model applies to debt instruments (such as bank deposits, loans, debt securities and trade receivables) recorded at discounted cost or at market value and recorded in the income statement through other comprehensive income, including lease receivables, contract assets, loan commitments and financial guarantee contracts that are not measured at market value through profit or loss.

As a result, entities will have to recognise not only incurred credit losses but also losses that are expected to be incurred in future.

The implementation of IFRS 9 is expected to have a major impact on the liquidity, profitability and capital positions of financial institutions since banks and other financial institutions may have to set aside greater provisions for expected credit losses in determining their profit or loss.

The provisions will adversely affect the profit or loss position of financial institutions in the first few years of implementation of the standard.

This will necessitate adjustment of banks’ financial and regulatory reporting frameworks to facilitate compliance under the ECL model.

It is, however, important to note that while the banks will be expected to make enhanced provisions for expected credit losses, each institution will make its own assessment on the creditworthiness of its customers without resorting to undue denial of credit under the pretext of the new accounting standard.

The new standard will require borrowers to be extremely disciplined in loan repayment and prudent in borrowing. The records of a borrower will be strictly scrutinised before loans can be provided.

This in effect will mean that access to loans will be dependent on the credit history of the borrowers and the micro economic conditions prevailing.

For banks and other financial institutions, the standard will imply a check on capital adequacy, profitability and liquidity which will have to be monitored by CBK who are the regulators.

Contrary to earlier media reports, the standards became effective this month. No entity was exempted from application of the standard.

The Central Bank of Kenya only proposed for a transition period of five years on capital adequacy and liquidity which the financial institutions to meet within a specified period.

Edwin Makori is Chief Executive officer, ICPAK.

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