The deadline for IFRS 9 is just over six months away. Here Compliance Matters undertakes a rare foray into the world of banking solvency with a discussion of one of the International Accounting Standards Board's new rules and its likely effect on credit for HNWs.

Banks and credit institutions will need to make sure that they are prepared for the new accounting standards and have successfully started to operate their new models for calculating loan impairments and provisioning for annual periods, beginning on or after 1 January 2018.

To date, financial firms have been concentrating on the logistical problems of implementing IFRS 9. After all, it will make life considerably more complex for lenders – and the shift from the current 'incurred loss' model to a forward-looking system of provisioning will require more resources as banks struggle to do the necessary benchmarking, modelling and stress testing.

However, in addition to the challenge of regulatory compliance, financial institutions also need to consider the wider effects of IFRS 9 on their operations and future business. For instance, the new system of provisioning may increase the volatility of banks’ earnings and capital, which in turn is likely to affect their capital ratios and financial planning.

Sharper and earlier losses on balance sheets

There is some concern that the new system of provisioning under IFRS 9 will have a pro-cyclical effect on bank balance sheets and lending. Current accounting standards ensure a late recognition of losses – lenders assume that loans will be repaid until evidence to the contrary is identified. Under IFRS 9, long-term forecasting about provisioning is to be required, stemming from empirical evidence and modelling, which means that losses on balance sheets may appear sharper and earlier.

This is, in many ways, a good thing. This shift should provide a more longer-term and consistent approach to expected loss calculations and, in theory, should lead banks to make better decisions about lending. However, if banks 'frontload' the loan losses at the start of a recession, it could affect lending capacity just at the moment when it is needed the most to keep good business going.

Banks need to understand these future effects of IFRS 9 better than they do today in order to avoid lending too little at the wrong time in the cycle. The effects may be revealed more clearly in the stress tests that the Bank of England and the European Banking Authority are going to conduct next year.

It should also be noted that IFRS 9's rules could affect different types of lending products in different ways. For instance, the provisioning for mortgages should not be affected too much, as lenders already take a long-term outlook on such loans, whereas the effect on more short-term unsecured loans could be much greater. The effect of the new standard on revolving credit facilities, such as credit cards, could be significant because of the complexity involved in determining the length of the loans. Other areas of consumer credit could be restricted by IFRS 9 rules, particularly among non-bank lenders such as utility and mobile phone companies. It is questionable whether such lenders are fully prepared for these IFRS 9-related changes. If they are not, they might have to make changes to their products and services.

Choppy waters ahead

The full effect of IFRS 9 on lenders is only likely to be known once the new standard has been tested in tough market conditions. Its effects may be obvious sooner than originally expected, as IFRS 9 is likely to come into force at a time of considerable macroeconomic and regulatory turmoil. Banks and their HNW customers might, indeed, experience such turmoil even before that date.