On 20 March, the European Central Bank (ECB) announced further measures to ensure that its directly supervised banks can continue to “fulfil their role to fund households and corporations amid the coronavirus-related economic shock to the global economy”. As part of these measures the ECB encouraged banks to “avoid excessive procyclical effects when applying the IFRS 9 international accounting standard”.
IFRS 9 requires banks to increase provision levels when there is a credit deterioration of a loan. Required provisions will also increase when the economic outlook is expected to deteriorate in future. As the current economic outlook is rapidly deteriorating, IFRS 9 would result in drastically increasing provisions. Within its prudential remit, the ECB recommends that “all banks avoid procyclical assumptions in their models to determine provisions and that those banks that have not done this so far opt for the IFRS 9 transitional rules”.
On 25 March, the European Banking Authority (EBA) issued a statement where they clarified that “there is no automatic classification in default, forborne, or IFRS9 status”. Like the ECB, the EBA wants to prevent that banks’ provisions grow rapidly, hindering the much-needed financing to the market. The EBA highlighted that “when applying the IFRS 9 international accounting standard, institutions are expected to use a certain degree of judgement and distinguish between borrowers whose credit standing would not be significantly affected by the current situation in the long term, and those who would be unlikely to restore their creditworthiness”. In other words, the EBA seems to take the stance that the increase in provisioning should only be applied if the credit deterioration is not linked to the outbreak of the coronavirus.
The European Securities and Markets Authority (ESMA) also issued a statement in which they argue that “the principles-based nature of IFRS 9 includes sufficient flexibility to faithfully reflect the specific circumstances of the COVID-19 outbreak and the associated public policy measures”.
Furthermore, local regulators have also commented on the application of IFRS 9 in the context of the coronavirus. The Prudential Regulation Authority (PRA), together with other UK authorities, provided guidance to UK banks, building societies and PRA-designated investment firms regarding the applications of IFRS 9. This includes the extent to which missed payments should constitute an event of default or should otherwise attract a lifetime expected loss provision. The PRA takes a similar stance as the EBA by expecting lenders “to treat covenant breaches that relate to the coronavirus differently compared to uncertainties that arise because of borrower-specific issues”.
It remains to be seen to what extent banks can exploit the room that the ECB and other regulators are trying to provide, as (a changed) application of the accounting rules needs to be approved with each bank’s auditor. This is not part of the responsibilities of the ECB and EBA.
Please contact Tim Neijs for more information on the coronacrisis impact on IFRS 9.