The Central Bank of UAE has issued a statement in which it has introduced a new requirement for all banks to apply anInternational Financial Reporting Standards 9’s (IFRS 9) expected credit loss (ECL) provisions to decrease provision necessities.
Prudential filter aims to minimize the effects of IFRS 9 provisions on regulatory capital, in view of expected volatility due to the Coronavirus crisis. The Central Bank of UAE (CBUAE) mentioned that any increase in the provisioning compared to 31 December 2019 will be partially added back to regulatory capital.
There will be 2 major benefits due to these relaxations:
1. More flexibility for banks:
Analysts say that the change in approach to IFRS 9 is in sync with the economic consequences of the Coronavirus outbreak on the economy and the banking sector.
“Introducing transitional arrangements for the accounting of expected credit losses at banks will delay banks’ creation of provisioning buffers to absorb potential future credit losses, a credit negative.
KPMG thinks that it is currently difficult to incorporate the special effects of COVID-19 and government support measures on a reasonable and supportable basis. However, changes in economic conditions should be reflected in macroeconomic scenarios applied by entities and in their weightings.
Analysts also believe that IFRS 9 and the associated disclosures can provide much-needed transparency to users on financial statements.
According to KPMG, under the current uncertain economic environment, lending institutions will need to analyze any such arrangements (temporary relaxation in IFRS 9 reporting standards) carefully to determine the appropriate accounting.
By providing temporary relaxation in reporting standards, the CBUAE expects banks to maintain transparency in their accounting on the impact of COVID-19.
Finally, Let’s have a look at IFRS 9 and its reporting necessities:
UAE banks adopted the International Financial Reporting Standards (IFRS 9) from January 1, 2018.
Effective for annual periods beginning on or after January 1, 2018, IFRS 9 set out how banks should classify and measure financial assets and financial liabilities. Its scope includes the recognition of impairment. In the standard that preceded IFRS 9, the “incurred loss” framework required banks to recognize credit losses only when evidence of a loss was apparent.
Under IFRS 9’s expected credit loss (ECL) impairment framework, banks are required to recognize ECLs at all times, taking into account past events, current conditions and forecast information, and to update the amount of ECLs recognized at each reporting date to reflect changes in an asset’s credit risk.
It is a more forward-looking approach than its predecessor and will result in more timely recognition of credit losses and a likely increase in NPLs. At a time of the global economy is facing a pandemic crisis and economic crisis, the strict application of IFRS 9 and ECL reporting looks unviable and regulators are supportive of the current requirements.
Level loss recognition
Under the ECL framework impairment of loans are recognized under three stages:
Stage 1: When a loan is originated or purchased, ECLs resulting from default events that are possible within the next 12 months are recognized (12-month ECL) and a loss allowance is established.
Stage 2: If a loan’s credit risk has increased significantly since initial recognition and is not considered low, lifetime ECLs are recognized. The calculation of interest revenue is the same as for stage 1.
Stage 3: If the loan’s credit risk increases to the point where it is considered credit-impaired, interest revenue is calculated based on the loan’s amortized cost (that is, the gross carrying amount less the loss allowance). Lifetime ECLs are recognized, as in Stage two. Twelve month versus lifetime expected credit losses ECLs reflect management’s expectations of shortfalls in the collection of contractual cash flows.