The adoption of the International Financial Reporting Standard 9 (IFRS 9): Its main aspects, its effects on financial stability and its impact on the three significant institutions operating in Cyprus
Filippou, Akos Marios
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The International Financial Reporting Standard 9 (“IFRS 9”) emerged from the aftermath of the global financial crisis, aiming to address the shortcomings of preceding accounting standards, particularly with respect to the valuation of financial instruments. The shift from the incurred loss model used by International Accounting Standard 39 to the IFRS 9’s Expected Credit Loss (“ECL”) model constituted a shift in paradigm. The IFRS 9 mandates the forward-looking recognition of ECLs over the time horizon of twelve months on financial assets carried at amortised cost, despite the lack of credit loss or trigger events and in case the financial asset exhibits a significant increase in credit risk, the recognition of ECLs over the lifetime of the asset. The adoption of the IFRS 9 is of particular importance to Cyprus credit institutions since they are required by law to follow the International Accounting Standards adopted by the European Union (“EU”). More importantly, the nature of their operations entails the holding of significant amounts of financial assets and financial liabilities. As a result, they are exposed to significant levels of credit risk, particularly when the idiosyncrasies of the Cyprus financial landscape are taken into consideration. When this risk materialises, or when credit institutions recognise credit loss allowances against this risk, their prudential capital position is deteriorated directly. As such, the transition to the IFRS 9 had a more profound effect on credit institutions compared to non-financial entities. Based on the above and because of the important role of credit institutions in financing the real economy, the transition to the IFRS 9 entails financial stability considerations. The day-one effect on EU credit institutions of the adoption of the was a reduction of 47 basis points on average of their common equity tier 1 (“CET 1”) capital ratio. To counter this reduction, credit institutions might deleverage (sell-off assets) or reduce their lending to the real economy. Studies also suggest that despite of its intentions to the contrary, the IFRS 9 might lead credit institutions to act procyclically because of its forward looking ECL model. Regardless of the above, it is argued that the IFRS 9 could be less procyclical than its predecessor, may lead to improved loan pricing and could incentivise credit institutions to grant shorter term loans. In terms of the impact of the adoption of IFRS 9 on the three Significant Institutions (“SIs”) operating in Cyprus, the study shows a somehow mixed picture. On the first day of the adoption of the IFRS 9, all three SIs had a sizable increase in their credit loss allowances due to the remeasurement of opening credit loss allowances using the IFRS 9’s ECL model. The opening credit loss allowances of Bank of Cyprus Public Company Ltd (“BoC”) increased by 8.3%, those of Hellenic Bank Public Company Ltd (“HB”) increased by 2.9%, while RCB Bank Ltd (“RCB”) experienced an increase of opening credit loss allowances of 46.5%, albeit from a very low base. Both BoC and HB adopted the transitional provisions for the phasing-in of the impact of the adoption of the IFRS 9 for prudential purposes, whereas RCB opted not to use transitional provisions for prudential purposes. The day-one adverse impact of the adoption of the IFRS on BoC’s prudential CET 1 capital ratio was estimated at 158 basis points, on HB’s prudential CET 1 capital ratio the total impact was estimated at 98 basis points, whereas the impact on RCB’s prudential CET1 capital ratio was estimated to be 38 basis points, albeit the calculation for RCB entails some caveats. None of the three SIs exhibited an observable shift in its provisioning practices due to the adoption of the IFRS 9, although conclusions cannot be drawn with confidence, since BoC and HB underwent significant structural changes during the period under review.