Expected credit loss amid aftermath of the coronavirus outbreak
At transition date in 2018, Deloitte Nigeria in one of its reports faulted application of the International Financial Reporting Standard 9 by the Nigerian Banks.
Early credit provisioning was one of the main objectives of accounting standard setters when they issued the IFRS 9 for loan losses.
IFRS 9 sought to prevent banks from provisioning insufficiently and too late, an issue the 2008 financial crisis brought to light.
Moody said as expected, in the first quarter, there was disconnect between credit provisioning and delinquency and charge-off trends.
While provisions increased materially for many banks in the first quarter, impairments and charge-offs did not grow as significantly because the latter takes time to materialize.
Loan losses are generally highly correlated with economic indicators, so ECL provisions booked at the end of March included future expected losses.
Meanwhile, many banks applied International Financial Reporting Standard 9 impairment provisioning modelling differently, thereby making comparison a tough task, Deloitte Nigeria’s said in a report.
According to Deloitte, it said the comparability challenges stemmed from the application of IFRS 9 impairment provision overlays, presentation of quantitative disclosure comparatives, and setting significant increase in credit risk (SICR) thresholds among others.
It observed that many banks made inadequate disclosures, some banks disclosed the transition count from and to the various stages without disclosing the balances of the accounts that transited.
Deloitte, in the report that covers top five banks Access, Zenith, FBN, UBA and GTB reiterates that it expects that over time the differences in approaches will reduce following pressure and additional guidance from regulators and peer group assessments.
According to the report, the implementation of the IFRS 9 in 2018 raised banks provisioning level on transition.
“It is clear that IFRS 9 has given the banks latitude to make differing judgements when modelling impairment provisions”, Deloitte said.
The firm however observed that what still remains unknown is the long term consequences of banks implementing differing IFRS 9 impairment provision modelling judgements.
This includes, but not limited to, assumptions on the probability of default, cash/unsecured recovery rates, cure rates, collateral projections; estimation of EIR and re-default probabilities, the report reads.
Deloitte agreed that the Nigerian banking industry, in particular the large lenders, invested significant resources to keep up with financial reporting for IFRS 9.
It however revealed that despite the level of resources deployed, there were still certain aspects that makes comparisons between the banks challenging.
IFRS 9: Impact on the Nigerian banking industry
Deloitte said the FBN Holdings Plc group results were used for First Bank of Nigeria Limited where FBN numbers were not separately disclosed.
The firm noted that the initial impact of IFRS 9 on the banks’ financial results showed some significant effect as many had expected.
“The banks recognised increases in total IFRS 9 provisioning of 72% to 160% at transition as at 1 January 2018 largely driven by full provisions on stage 3 exposures”, the firm noted.
According to the report, this resulted in a direct reduction of retained earnings reserves.
It was observed that a number of offsetting forces, such as the reduction in retained earnings, IFRS 9 transitional arrangements and other related regulatory adjustments, resulted in some volatility between regulatory capital constituents.
By the end of the 2018 reporting period, most of these banks had reflected decreases in total IFRS 9 impairment provisions for loans and advances to customers of between 16% – 40%.
The decrease that the banks experienced was partly driven by an improvement on the quality of data, better understanding and improvement of impact areas of IFRS 9 but more especially due to the advance hit taken at transition.
It is clear that IFRS 9 has allowed the banks latitude to make differing judgements when modelling IFRS 9 impairment provisions, Deloitte held.
The firm stated that notable examples of differing judgements are in terms of the significant increase in credit risk, SICR, thresholds implemented, IFRS 9 impairment provision.
It also include overlays/post model adjustments, macroeconomic scenarios structure and weightings, sensitivity analysis disclosures and revolving facility expected lifetime assumptions.
“It is however not yet known how total IFRS 9 impairment provisions and impairment charges will behave during future periods of stress”, the report reads.
Deloitte said going forward, some considerations resulting from publicly available information within the Nigerian economy which includes,
…but not limited to factors such as exiting recession, CBN regulation and interventions such as loan to deposit ratio,
…the capital adequacy ratio, CAR, may cause the banks to take in additional impairment overlays and post model adjustments as UK Banks did with respect to BREXIT.
The report states that it is expected that banks take precautions and back-test/stress test their current IFRS 9 models and make relevant adjustments to the current models being used by the banks
It was discovered that most banks did not disclose the methodology applied in the estimation of expected credit loss (ECL).
It is important that banks make further disclosure on the methodology applied, the firm said.
Also Deloitte said most banks experienced challenges in the quality of data used in the implementation of IFRS 9.
The firm advises that it may be important for banks to revisit their IFRS 9 implementation report and put in place processes and systems to reduce the data gaps experienced.
“We expect that over time the differences in approaches will reduce following pressure and additional guidance from regulators and peer group assessments”, Deloitte noted.
Use of IFRS 9 impairment provision overlays
Majority of the banks applied IFRS 9 impairment provision overlays relating to uncertainties that are based on management best estimates for significantly material individual loans.
Deloitte explained that despite the fact that banks applied overlay; especially for significant exposures; there were limited disclosures on the drivers of the overlays,
..the value of the overlays in relation to the impairment for the accounts involved and the outstanding balances which the overlays were applied on.
It stressed that the disclosures in the banks’ financial statements stated that the banks applied qualitative adjustments and overlays to reflect other characteristics of the market not captured at the date of the financial statements.
However, further disclosures from the banks on impairment overlays were not captured in detail in the financial statements.
Presentation of quantitative disclosure comparatives
Meanwhile, the firm stated that banks have not consistently presented comparatives in the quantitative disclosures included in the Credit Risk and Notes to the Financial Statement sections of the Annual Reports.
Deloitte shows that in certain cases the 31 December 2017 balances (IAS 39) are shown alongside 31 December 2018 (IFRS 9) balances, which may not be comparable.
It added that in some other cases the 1 January 2018 balances (IFRS 9) are shown alongside 31 December 2017 (IAS 39) and 31 December 2018 (IFRS 9).
Some banks disclosed the transition count from and to the various stages without disclosing the balances of the accounts that transited.
While some other banks disclosed the transition values from and to various stages without disclosing the count of the accounts that transited.
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Some others did not disclose both transition of counts and balances between stages.
“Most banks experienced challenges in the quality of data used in the implementation of IFRS 9. It may be important for banks to revisit their IFRS 9 implementation report and put in place processes and systems to reduce the data gaps experienced.
“Most banks did not disclose the methodology applied in the estimation of Expected Credit Loss. It is important that banks make further disclosure on the methodology applied.
“Common methodologies used by the banks include but not limited to transition matrix, run-off triangle, PD mapping to rating scales etc.”, Deloitte explained.
Expected credit loss amid aftermath of the coronavirus outbreak