The Accountant: Could you tell me a bit about the Banks Working Party?
Berkhard Eckes: The Banks Working Party is part of Accountancy Europe, focussing on the financial services industry and the banking industry. We bring together accountants, auditors, and financial experts to discuss the main challenges of the profession, from the audit professions position, and engage with the industry key stakeholders. We have a lot of projects linked to the role of auditors in getting banks more safe and sound in the future, which requires learning from the past. We work on banking supervision, meaning we are working on the relevant financial regulations and supervision improvements to help ensure the European economy is properly financed and risk is properly managed. Another one is reporting on audit impacts of IFRS 9. Also, what is the scope of the audit of banks beyond financial statements – are auditors also engaged in their regular work focussing on regulatory and prudential reporting, as well as looking at nonperforming loans.
TA: What is the current status of IFRS 9, and are you happy with where it is?
BE: We have to take it as it is. It is now the standard. It has been discussed for 8,9, 10 years. At the end of the day it is a compromise. The good thing is now we have expected loss over lifetime. IAS 39 was incurred loss, but now we have expected loss over lifetime, which means the banks have to think ahead about what could be the impact of future developments in the economy, what do they see in the market and how could this impact on the provision of loans. This means the banks have to take a deeper look at the future, which is difficult to do. On the other hand, this leads to the fact that banks have to book the provisions earlier than they did in the past. Regarding the challenges of implementation: one thing is availability of data. You need data for this. You need historical data and an IT infrastructure able to do these calculations. You have to be able to define what it means to have a significant increase of credit risk. What does that really mean? It’s just set in IFRS as ‘significant increase’, but it doesn’t make a clear definition of what that means. So I think in the first year or two you will see a little bit of divergence in practise around the criteria that banks are using. It might be slightly different from bank to bank, but we’ll need to wait and see how that develops. Another challenge is the calculation and the type of model to use. IFRS 9 is not clear on that. You may see divergence in practise regarding the methodology and models banks are using. These are the main challenges we’ve seen so far. IAS 39 has lasted 5 to 6 years. IFRS 9 is much more complicated so it will take more time to get it implemented in practice.
TA: What will be the benefits of IFRS 9?
BE: The banks will book the impairment a bit earlier. But there is also a potential risk because banks have to take scenarios and base their calculations on the expected loss on these. Of course if you ask 10 people ‘what is the future development of this and this economy, you will get 11 answers. In other words it’s not very clear. So you’ll see some divergence here, although I don’t expect huge divergence. Until now, we have no practical experience – IFRS 9 was just implemented. Most of the banks will publish the first impacts on their half year accounts for 2018. All the banks have to publish their impact by the end of 2018. Then we will see what will become the benchmark, but we don’t have the experience to say what will be the end of the day impact of IFRS 9.
TA: Could this divergence give some an advantage over others?
BE: That is difficult to say. From our point of view as auditors, our role is very clear. We have to look at all these models and decide if the calculation is in line with IFRS 9. Of course we also take into account what other banks are doing and what seems to be the benchmark. It is good that IFRS 9 is principles based, and as such aims to reflect the substance of the transactions, but from a consistency view that is a disadvantage because it is not so clearly defined.
TA: Is making sure everyone is consistent a challenge as this is the first time around?
BE: From an auditor’s perspective, we clearly ask if what the banks are doing is in line with IFRS 9 – yes or no? There is always an issue with how you define consistency. From an audits point of view, consistency means if it is in line with IFRS 9, and that is how we have to look at it, taking into account that banks are different, markets are different, the data is different, and so on. We get the impression that supervisors are thinking about how they can, for prudential reasons, define some expectations and requirements regarding IFRS9. I think there is some discussion with the European Central Bank. Legally it is not allowed to do any kind of interpretation for accounting purposes, but for prudential reasons they can set up guidelines, guidance, and so on.
TA: How does this interplay with the risk reduction going through?
BE: I would put this together with the nonperforming loans topic. For me these are two things clearly linked together. Regarding the Risk Reduction Measure package: The European Commission published in 2016 this risk reduction package, and they have 3 areas of focus:
- Measures to increase the resilience of the new banking institutions and enhancing financial stability. That includes, for example, they will set up more risk sensitive capital requirements. They will set up a binding leverage ratio to prevent institutions form excessive leverage, and also binding less stable funding ratios to address the excessive reliance on short term wholesale funding.
- The second part is focussing on measures to increase banks’ lending capacity to support EU economies. For example to enhance the capacity of banks to lend to SMEs and to fund infrastructure projects to make CRB and CRR more proportionate and less burdensome for smaller and less complex institutions.
- Number 3 is measures to further facilitate the role of banks in achieving deeper and more liquid new capital markets.
From the Banks Working Party, we are supporting of these measures, and think these are good ideas, though this also depends on how this will become in practise. There needs to be proportionality, for example. The other part which is linked is the nonperforming loan topic. The European Central Bank (ECB) has published guidance to banks on non-performing loans, and they have also published an addendum. This addendum says that for all loans that become non performing after April 1st, the bank has to calculate the full provision of the situ of the unsecured part after 2 years, and for the secured part they have to calculate the full provision after 7. The ECB wants banks booking this in the financial statements. This is an issue where we are in discussion with the ECB, because if you look at these rules, this is not in line with IFRS 9. We are saying to the ECB ‘you can ask the banks to do this, but please bear in mind that it is not in line with accounting rules.’ Banks have different kinds of portfolios. This addendum is focussing on new nonperforming loans – loans already given to customers which will become non performing in the future.
TA: What about the legacy portfolio?
BE: For the legacy portfolio, the IFRS 9 rules are clearly important and applicable, and the bank has to finish this. So for the legacy portfolio, they do not have to follow the addendum ones, that is our understanding. Also focussing on non-performing loans, in December 2017 the European Commission (EC) published a paper where they described how banks should calculate provisions for newly originated loans that turns into non performing loans. These rules say if the newly originated loans become non performing, the bank has to calculate the full provision for the unsecured part of these loans, and after 8 years 100% provision of the secured part of the loans. It also introduced a haircut approach, meaning depending what type of collateral a bank has, it has to calculate an initial haircut on the collateral. What we are saying, through the Banks Working Party, is that we see a lot of value in any initiative aimed at reducing nonperforming loans in bank financial statements, and we intend to support the Commission. But nevertheless, to ensure that this aim is well served, you need to ensure the integrity of the accounting rules, and that technical specificities are considered. The addendum of the ECB and the paper from the EC are not in line with accounting rules. So it means at the end of the day banks have to consider different kinds of portfolios. One is a legacy portfolio following IFRS. Then you have the addendum portfolio, only focussing on non-performing loans of those already on your books, with its 2 and 7 year rules. Then you have the EC paper, which has an impact on all banks, which has a 2 and 8 year impact, but only for newly originated loans. So this is something we think has to be thought through more carefully. We clearly see questions about the integrity of the accounting rules, because so far they haven’t been in line.
TA: When you talk to the ECB and Commission, how receptive have they been to this point?
BE: Positive. My impression is they appreciate having this kind of discussion. They clearly understand our remarks and concerns.On the other side, my impression is they feel that as supervisors they want to reduce the risks within the banks and their balance sheets. We understand coming from this objective, why the ECB and EC want to set out these rules, to put pressure on the banks to do something. But they also need to take into account this might not be in line with accounting. It could happen that a bank has to book provisions, following IFRS 9 rules. Then they have to calculate provisions following the addendum rules or EC rules, which might be different from the IFRS 9 rules. The IFRS 9 number has to be booked into the accounts while the other cannot be, so they will have to take this number and subtract it for prudential reasons from their core capital. They understood this, but I do not think they’ll change their rules, because they are coming from that prudential point of view.
TA: The 2008 banking crisis took us by surprise. Bearing in mind IFRS 9 and these other measures we’ve discussed, are we better prepared?
BE: I would say, regarding the reasons why we had the financial crisis in 2008, we are now much better prepared than before. Banks have built up more capital. The rules around what you are allowed and not allowed to do are stronger. The single supervisory mechanisms and the single resolution mechanisms have led to a level playing field among banks within the Eurozone. But if or when there is the next crisis we will have other kinds of reasons. If you take, for example, geopolitical uncertainty: what do you do if you’re a bank with that? Another risk which is increasing is cyber risk.
Source: The Accountant-Online