IFRS 9 promises to have a marked effect on banks' financial results and it is becoming clear that it will have an equally significant impact on supervision. In particular, the quality of IFRS 9 implementation will affect several important elements of the Supervisory Review and Evaluation Process (SREP). To avoid problems, banks need to ensure they are keeping a close eye on IFRS 9's qualitative requirements, not just its quantitative effects.
Europe's banks have expended a great deal of time, effort and money into implementing IFRS 9. To date, their primary focus has been on making reasonable judgements about asset classification and the new expected loss provisioning methodology. For IFRS 9 the focus will shift to include communicating the resulting impact to investors, making further enhancements to models and accounting infrastructure, and running this year's regulatory stress tests with IFRS 9 methodologies. Already we have seen that those European banks who have disclosed their IFRS9 impact on CET1 seems to be less than from the EBA impact assessments in 2016 and 2017.
Europe's supervisory authorities have also been busy during the implementation phase. The EBA has conducted two IFRS 9 impact assessments, the ECB has carried out a thematic review into IFRS 9, and ESMA has issued Public Statements to promote transparent information for the users of financial statements. Supervisory authorities have studied the quantitative effects, including the accounting change for provisions and the impact on regulatory capital. And they have kept a close eye on qualitative factors such as implementation processes and governance.
The ECB is showing growing interest in provisioning (as evidenced by their NPL addendum), and is keen to ensure that SSM banks apply IFRS 9 consistently and can substantiate their judgements. For example, the ECB:
We can already see IFRS 9 having a tangible impact on bank's SREP. As part of the 2017 SREP, all in-scope banks received letters covering the results of the IFRS 9 thematic review. Most were also sent follow-up letters requiring them to address specific concerns and respond to the ECB accordingly. Common areas of focus included business models, forecasts, ECL model testing, governance and documentation.
Looking ahead, the signs are that IFRS 9 will have an even greater impact on the 2018 SREP. We expect the ECB to conduct a horizontal review of approaches to IFRS 9, with the results informing the work of JSTs. Banks perceived as `outliers' could attract particular attention. This year's regulatory stress tests are the first to include IFRS 9, and that too will impact the SREP given some banks may struggle across the areas of data quality, methodological robustness and clarity of disclosures.
In our view, most banks should expect IFRS 9 to affect all four of the SREP's key elements:
In conclusion, banks should be aware that IFRS 9 will have a significant and lasting impact on the SREP, especially in the area of governance. If the accounting provisions are not conservative enough supervisors may set up mechanical prudential backstops for regulatory reporting, which are not in line with IFRS rules (much as we have seen happen with NPL regulatory reporting). Banks need to ensure they are paying as much attention to the qualitative aspects of IFRS 9 as they are to the quantitative impact on provisioning. If not, they run the risk of attracting additional supervisory attention and potential prudential add-ons for Pillar 2 capital buffer requirements.