A video by the International Accounting Standards Boards (IASB) explains the background to IFRS 9’s new loan loss accounting requirement and how it contributes to financial stability.

Addressing 'too little too late'

IASB vice-chair Sue Lloyd talks about the background of IFRS 9, which will replace IAS 39. That latter was criticised for being too complex and for requiring 'too little too late', in terms of causing banks to recognise losses on bank loans and other financial assets. While IAS 39 was based on 'incurred loss accounting', requiring banks to provision for loan losses only when there was hard evidence that losses were occurring, IFRS 9, which is due to become effective from January 2018, will replace the incurred loss model with an expected loss model, which means that banks or other financial institutions must begin accounting for expected loan losses from the day they first lend money or invest in a financial instrument. They will also need to take a greater range of information into account under IFRS 9, including forward-looking information, so if a bank expects credit conditions to decline, this must be reflected in its loan-loss calculations immediately.

Bank loan risks more visible

IASB member Stephen Cooper notes that IFRS 9 also makes a bank's credit risk exposures more visible to investors. He says: “This means that if a loan goes from performing as expected to performing significantly worse than expected, investors will get information about that.” He adds: “In some situations the old system of IAS 39 created more volatility in the financial results than IFRS 9 will. This is because banks went from no provisions to recognising full losses when payments stopped, creating even more dramatic changes. Nevertheless, a more responsive loan-loss provision could mean more volatility in banks' financial results under IFRS 9. However, the accounting doesn't create volatility, it only reflects the economic changes. Some have suggested that reflecting the impact of economic volatility in financial statements must by definition be inconsistent with financial stability. We disagree. The IASB's mission is to develop standards that bring transparency, accountability and efficiency to the financial markets around the world."

Loan-loss provision will be higher under IFRS 9

And according to IASB member Darrel Scott, when a bank applies IFRS 9 its loan-loss provisioning is likely to end up being higher than it was under IAS 39. He explains: “This in turn will mean that accounting equity will go down. However that doesn't automatically have an impact on the levels of capital that banks will need to hold.”

IFRS Perspective: Loan loss accounting and financial stability