Countries across Asia Pacific roll out financial reporting regulations based on an international framework

The banks of the Asia-Pacific region have been subject to successive waves of regulatory changes in recent years. Remaining compliant with strengthened anti-money laundering rules, know-your-customer guidelines and a raft of sustainability and transparency initiatives proved to be a resource-consuming process for the region’s lending institutions.

However, one regulatory shift in particular has monopolised the attention of banks’ management and audit committees. The International Financial Reporting Standards (IFRS) 9 will replace the International Accounting Standards 39 (IAS 39) framework, which for more than a decade was widely considered too complex, inconsistent and unnecessarily high risk. Even before the global financial crisis of 2008 the International Accounting Standards Board worked to address the weaknesses of IAS 39, chief of which was the framework’s deferral of the recognition of credit losses to a late stage of the credit cycle. Post-crisis, it became clear that a complete revision of the standard was necessary and the formulation of IFRS 9 as a replacement to the framework became a key priority. The final IFRS 9 was established in 2014 and went into effect January 1, 2018. Banks around the world have thus had time to gauge the potential impact of what is, in effect, a worldwide regulatory move towards a more sustainable financial environment.

What is New 

IFRS 9 introduced a number of significant changes to the way banks classify and manage their financial assets. In general, the new standards compels banks to evaluate how changes to both credit conditions and the economic backdrop will alter their business models, portfolios, capital allocation and provisioning levels. Perhaps the most notable of the regulatory changes from a procedural perspective is the transition from the bright line tests of the IAS 39 standards that were characterised by a broad array of strictly defined and often arbitrary rules, to a fine line approach. According to the new standards, a single model is deployed to classify and measure the fair value of assets, with changes in fair value recognised in profit or loss as they arise.

For banks, the second major change introduced by IFRS 9 relates to the treatment of impaired assets. The impairment assessment approach of IAS 39 was replaced by an expected loss model, by which banks are asked to assess all loans and receivables against various probability-weighted default scenarios. The output of this process establishes the allowance that banks must make for potential cash shortfalls arising from lending activities or other receivables. Every loan and receivable carries some risk of default or impairment, and under the new system this risk is to be assessed from the date of its origin or acquisition to its completion. If a bank manages to recoup the full loan, expected losses eventually decline to zero as the probability of non-payment falls, and this is recognised in profit and loss. If the loan grows more risky, however, the likelihood of a default increases, and therefore expected credit losses will follow.

Regional Implications 

IFRS 9 poses a number of challenges to banks in the region, especially in terms of provisioning practices. Under IAS 39 a provision was made only when an impairment was realised, but under the more comprehensive IFRS 9 approach, banks must take a forward-looking consideration from the point of the loan’s origin. “With the shift in provisoning from an incurred loss model to an expected credit loss model, banks can expect greater volatility in provisioning outcomes,” Robin Fleming, CEO of the Bank of South Pacific, told OBG. “Nonetheless, early recognition of increases in credit risk allows for prudent provisoning practices, with adequate allowances set aside for potential loss events.”

Provisioning levels for banks are therefore expected to increase under the new framework – a development which will have knock-on effects in other areas of performance. For many shareholders and other stakeholders, the impact on banks’ bottom lines is the biggest concern: if the expected loss model results in higher levels of provisioning, lower operating margins and reduced profitability are the likely result. Some banks may also feel the need to issue equity to maintain regulatory capital levels while accommodating the greater pro-cyclicality on lending and provisioning.

There is also the challenge of resources. In 2015 Moody’s Analytics surveyed 28 global banks of various sizes, around one-third of which maintained Asian operations. The results revealed that nearly half of the survey respondents allocated a budget in excess of $2m for IFRS 9 implementation. Moreover, costs associated with the new standards have not necessarily abated in the wake of its implementation: as banks are expected to make a forward-looking analysis covering the lifetime of a financial facility and monitor on an ongoing basis for credit quality deterioration, the need for suitably qualified human resources and an enhanced data capturing system remains. Expert advice is available at a price across the Asia Pacific, with the six major global accounting networks – BDO, Deloitte, EY, Grant Thornton, KPMG and PwC – actively promoting IFRS 9-related solutions to existing and potential clients. In the eyes of the accounting networks, the implementation of IFRS 9 is one of the most noteworthy changes to the world’s accounting landscape, and one that promises to provide fruitful opportunities for business expansion. The publication of a joint paper released by the aforementioned accounting firms offering guidance to audit committees of systemically important banks in the run-up to the implementation deadline was a rare instance of public cohesion and a reflection of the magnitude of the necessary transition.

Growth Opportunities  

Despite the associated challenges, the arrival of IFRS 9 also offers a number of important advantages to banks across the region. The new framework directly tackled the late recognition of credit losses that proved so costly during the 2008 global financial crisis. The unified model that replaced IAS 39’s arbitrary rules also reduced the complexity of impairment calculations, making it more difficult for potential risk to escape unnoticed. The higher volumes of data required by IFRS 9, meanwhile, increases the amount of information available to banks to help these institutions establish an effective and efficient risk management policy, and proactively manage provisions and their effect on capital plans.

More broadly, the information will allow the banks’ management to make better strategic decisions while national economies will benefit from sounder and more efficient banking sectors. Ultimately, this will result in improved investor confidence, which in some jurisdictions is a particularly desirable outcome: in Malaysia, for example, government-linked banks have historically been perceived as holding inadequate impaired loan coverage. The more comprehensive allowances against default prompted by the Malaysian Financial Reporting Standards 9, the national variant of IFRS 9, are expected to ease investor concern, according to Credit Suisse in September 2017.

Implementation 

Not all countries are implementing IFRS 9. Institutions in the US will continue to operate according to the Generally Accepted Accounting Principles, although the Financial Accounting Standards Board is in the process of introducing a framework similar to IFRS 9. In Asia, as well as other countries in the Americas, Oceania and Africa, IFRS 9 is being implemented through local endorsement processes or a convergence of national standards with the new international model. The previous versions of IFRS in Asia Pacific has differed widely from one jurisdiction to another, and these divergent approaches are being replicated in the adoption of the most recent iteration of the international standards.

Some regional jurisdictions have adopted IFRS wholesale. In Papua New Guinea, for example, the Accounting Standards Board requires that all banks adhere to IFRS, and in 2017 it re-confirmed its policy of approving new IFRS regulations without modification and with the same implementation dates.

Other regulators in the region have established proprietary accounting rules that are closely or sometimes entirely based on the IFRS framework. The Philippines adopted the IFRS regime as the Philippine Financial Reporting Standards (PFRS) 9 and applied the rules to all publicly listed companies, as well as those meeting a number of other criteria such as holding total assets of more than P350m ($6.5m) or companies that are preparing to issue a financial instrument in a public market. The Sri Lanka Financial Reporting Standards are essentially IFRS with a small number of modifications and are applied to all financial institutions. In Thailand, the Thai Financial Reporting Standards are aligned with the IFRS framework and the country has committed to adopting future IFRS regulations with a one-year delay in the initial implementation date. In recent years Indonesia’s Financial Accounting Standards Board has been revising its national accounting standards to more closely resemble the IFRS framework, and its national equivalent, PSAK 71, is slated for implementation in January 2020. In Myanmar, domestic public companies are required to use the Myanmar Financial Reporting Standards, which are identical to the IFRS introduced in 2010. The Myanmar Accountancy Council is moving towards the latest IFRS and set the 2022/23 financial year as the implementation deadline. The banking sector is included in this effort and many of the larger players are already mobilising resources. “We have already started the process of identifying a vendor to help us introduce the framework and are aiming for a 2020 implementation,” Tek Raj Parajuli, head of wholesale banking at Myanmar Citizens Bank, told OBG.

Outcomes 

The rollout of IFRS 9 and the national equivalents in Asia Pacific has been staggered, in some cases trailing the effective date of the international standard by over two years. However, early adopters in the region are already producing promising outcomes, such as Myanmar, while still in the early stages of implementation. According to PwC, eight out of the 11 listed commercial banks in the Philippines felt it necessary to increase their overall equity balance by as much as 5% as a result of PFRS 9. Loan-loss provisions increased for the majority of the lenders as was expected. However, due to the subtleties of the IFRS 9 credit methodology, which introduced a new category of stage two financial instruments (those not yet defaulted but that have experienced significant increase in credit risk), this outcome was not as straightforward as some predicted – three of the 11 banks showed a net decrease in loan-loss provisions in the new qualitative and quantitative analyses.

Banks in the region took various approaches in applying the forward looking element of IFRS 9. Most banks based their assumptions on variables such as inflation, GDP and foreign exchange rates, but a smaller number of mostly international banks also included more specific considerations such as Brexit and the US-China trade war in their forecasting. The flexibility granted to the banks in this regard is a useful cushion against the shock of regulatory change, allowing leeway in the framework’s implementation.

Looking Ahead 

While the Philippines’ implementation required some equity rebalancing, the effect of the PFRS 9 was not as great as some had feared. As countries prepare for their respective implementation deadlines, regional banks can take comfort from the experience of their peers in developed markets. In the UK, for example, banks saw increases in impairment provisions immediately after the January 1, 2018 implementation, which resulted in the anticipated reduction of retained earnings and consequences for regulatory capital resources. However, by the end of the year banks reported an aggregate decrease in impairment provisions. As such, the cumulative effect of the new framework was no significant degradation of banks’ financial results and regulatory capital.

The question of how IFRS 9 will affect the investing and credit practices of banks over the longer term, however, remains unanswered, even in more developed markets that implemented the standards in January 2018. Moreover, the implementation of the new framework has to date taken place in a relatively benign credit environment, so that little is known of how the expected loss model that IFRS 9 introduced will perform during inevitable periods of credit stress in the future. In the Asia-Pacific region differing national models and implementation timetables mean that it will be some time before a regional-level assessment can be made regarding the efficacy of the new approach. However, in the meantime the arrival of IFRS 9 in its various local iterations is doing much to satisfy investor demand for more transparency in financial reporting. In the markets where investor confidence has been a concern, this may be the most important benefit of the new standards in the short term.

You have reached the limit of premium articles you can view for free. 

Choose from the options below to purchase print or digital editions of our Reports. You can also purchase a website subscription giving you unlimited access to all of our Reports online for 12 months.

If you have already purchased this Report or have a website subscription, please login to continue.

The Report: Philippines 2019

Banking chapter from The Report: Philippines 2019

Cover of The Report: Philippines 2019

The Report

This article is from the Banking chapter of The Report: Philippines 2019. Explore other chapters from this report.