Photographer: Krisztian Bocsi/Bloomberg

EU Banks Face 18% Provision Spike Under New Accounting Rules

  • Study looked at IFRS 9 impact on about 50 banks of all sizes
  • EBA says impact mainly driven by impairment requirements

European banks will need to increase provisions by 18 percent on average to meet new rules on accounting for potential loan losses, according to the European Banking Authority.

The accounting standards known as IFRS 9, which are set to apply from 2018, will also take a toll on lenders’ balance sheets, shaving an average of 59 basis points from their top-quality capital ratios, according to the EBA study published on Thursday. The estimates were based on a survey of about 50 banks of all sizes across the 28-nation bloc, with most categorized as being of systemic importance either globally or domestically.

Behind one of the largest changes to accounting rules this century is the experience of the 2008 financial crisis, when lenders found themselves unable to make provisions against impairment until the losses were actually incurred. The new standards require banks to cover potential losses as soon as a loan is made, based on the expected shortfall indicated by their models.

“The impact is mainly driven by the impairment requirements,” said Delphine Reymondon, head of the capital, assets and liabilities management unit at the London-based EBA. “Most banks estimated at this stage a manageable impact” on their capital ratios, she said.

Top Management

IFRS 9 is an reporting standard for financial instruments developed by the International Accounting Standards Board.

The EBA, which launched the study in December last year, is planning a second assessment that will conclude around the end of the first quarter to better understand the impact and implementation of the new standard. The current study helped focus the attention of banks’ top management on the new standard, Reymondon said.

“Most of the banks are still in the design phase,” she said. “We have observed that larger banks are usually more advanced than smaller ones.’’

Implementation of the standard will require the involvement of different departments within the banks, according to the report. “Ownership of the project by senior management and the allocation of sufficient resources to it are necessary to ensure timely and high-quality implementation.”

One of the likely results of moving to the new standard will be greater earnings volatility, according to 75 percent of the banks surveyed. That’s in part because expected losses will be based on forward-looking information that will have to be reassessed every reporting period.

Accounting Policies

In a separate statement published on Thursday, the European Securities and Markets Authority said that it expects companies to be able to estimate the impact of the change on their reporting as the implementation date nears. As a result, the authority said in most cases it would be appropriate for companies to “provide disclosures about the changes in the accounting policies and their impacts on the entity’s financial statements (or magnitude of the impacts) in the period of initial application already prior to their 2017 annual financial reports.”

The EBA said it was aware that firms are still developing processes and models. It asked the respondents to its survey to reply on a best-efforts basis. The banks indicated a range of possible impacts, according to the EBA. The averages also change when the results are adjusted to take account of the different size of the banks.

“In addition, the portfolios of banks may change when IFRS 9 is first applied and the state of the economy may also be different at that time,” the EBA said in its report. “The observations in this report are indicative of the main trend in the EU banking sector at the time the exercise was performed, and the impact of IFRS 9 may be different when IFRS 9 is first applied.”

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