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EBA Report on Results from the Second EBA Impact Assessment of IFRS 9 Summary

Core Content

The European Banking Authority (EBA) conducted the second impact assessment exercise of IFRS 9 in November 2016, as part of its own-initiative project, to better understand the implementation progress, quantitative impact, and challenges associated with the new standard. The report, published on 13 July 2017, is based on responses from 54 institutions across 20 EU Member States, with a focus on the European Economic Area (EEA). The assessment was conducted in February 2017, using data as of 31 December 2016 or 30 September 2016.

The EBA aims to monitor the implementation of IFRS 9 by EU banks and ensure that the standard is applied in a high-quality and consistent manner, particularly in relation to prudential requirements. The report highlights both qualitative and quantitative observations and outlines areas for further work.

Main Observations

Qualitative Aspects

• Implementation Progress: Most banks are in the building or testing phase of IFRS 9 implementation, particularly for classification and measurement and impairment requirements. However, some banks are not sufficiently advanced.
• Stakeholder Involvement: There is an increase in stakeholder involvement, but some key stakeholders (e.g., board of directors and audit committees) are not fully engaged, which may lead to insufficient resource allocation and focus.
• Data Challenges: Data quality, availability of historical data, and the assessment of "significant increase in credit risk" are major challenges for banks. Simplifications may be necessary in the absence of data, but they must be applied consistently and with sound governance.
• Methodology and Governance: Banks are encouraged to leverage existing prudential models for IFRS 9, provided they are appropriately adapted. Sound governance is essential for the implementation of IFRS 9, especially in the context of ECL measurement.
• Operationalisation of Requirements: While the impact of classification and measurement is limited, the operationalisation of these requirements will still require significant resources.
• Volatility in Profit or Loss: 72% of banks expect IFRS 9 impairment requirements to increase volatility in profit or loss, mainly due to the "cliff effect" when moving exposures from stage 1 to stage 2 and the inclusion of forward-looking information in ECL estimation. However, 28% of banks do not expect a significant increase in volatility, as the ECL model may lead to a more gradual recognition of losses compared to IAS 39.
• Lending Practices and Financial Instruments: IFRS 9 may influence lending practices, but banks have not provided detailed estimates of this impact. Equity instruments are a minor part of banks' balance sheets, but their role in financing the economy is noted.

Quantitative Aspects

• Impact on Regulatory Ratios: The estimated impact of IFRS 9 on the CET1 ratio is an average decrease of 45 bps (compared to 59 bps in the first exercise), and on the total capital ratio, an average decrease of 35 bps (compared to 45 bps in the first exercise). The impact is expected to be limited overall.
• Provisions Increase: The average estimated increase in provisions under IFRS 9 compared to IAS 39 is 13% (compared to 18% in the first exercise), with up to 18% for 75% of respondents (compared to 30% for 86% of respondents in the first exercise). The lower increase in the second exercise may be due to improved implementation progress, better economic conditions, and more precise data collection.
• Bank Size Differences: Smaller banks, which mainly use the standardised approach (SA), are expected to experience a larger impact on own funds ratios than larger banks, which use the internal ratings-based (IRB) approach. Smaller banks cannot utilise Tier 2 capital for excess provisions under IFRS 9.
• ECL Measurement: The estimated impact of IFRS 9 on ECL is mainly driven by lifetime ECL for stage 2 exposures, particularly for loans and advances to households and non-financial corporations.

Areas of Further Work — The Way Forward

• Short-Term Actions:

  • The EBA Guidelines on ECL and BCBS guidance on credit risk and ECL will provide guidance for the robust implementation of IFRS 9.
  • The EBA supports a "static approach" to transitional arrangements, based on the initial impact of IFRS 9 on 1 January 2018.
  • The 2018 EU-wide stress test will take into account the implementation of IFRS 9.
  • Ongoing dialogue with banks and auditors is necessary to address implementation issues.

• Medium to Long-Term Actions:

  • A review of the implementation of the EBA Guidelines on ECL will be conducted to gain a better understanding of the various practices.
  • An analysis of the impact of different inputs, models, and methodologies on ECL measurement will be undertaken.
  • The EBA will continue to engage with EU and international bodies, including the Basel Committee on Banking Supervision (BCBS), to explore possible changes to the regulatory framework to ensure proper interaction with the new ECL model.

Key Information

• Objective: To understand the stage of preparation, estimated impact on regulatory capital, and implementation issues of IFRS 9.
• Sample: 54 institutions across 20 EU Member States, with a focus on smaller banks (14 banks, 26% of the sample).
• Quantitative Impact: The average estimated impact on CET1 ratio is a 45 bps decrease, and on total capital ratio, a 35 bps decrease.
• Challenges: Data quality, availability of historical data, and the assessment of credit risk are key challenges.
• Volatility Concerns: IFRS 9 may increase volatility in profit or loss, but some banks expect a more gradual recognition of losses.
• Recommendations: Banks should ensure sound governance, consistent methodologies, and robust validation processes for ECL models. The EBA will continue monitoring and engaging with stakeholders to support the implementation of IFRS 9.