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Nigerian lenders are faced with the possible negative consequences of making loan loss provisions as they gear-up for the adoption of International Financial Reporting Standard (IFRS-9) come January 1, 2018.
This is even as borrowers are advised to brace-up for tougher credit processes because the implementation of IFRS-9 will only present the lenders with more sophisticated ways of managing their credit risks.
In Nigeria, the use of internal data and modelling in assessing impairment and credit risk management has historically lagged behind the rest of the world, although there has been some improvement in these areas since the adoption of the International Financial Reporting Standards (IFRSs) in 2012.
IFRS-9 prescribes new guidelines for the classification and measurement of financial assets and liabilities, making fundamental changes to the methodology for measuring impairment losses by replacing the “incurred loss” methodology with a forward-looking “expected loss” model.
The implementation of IFRS 9, especially the expected loss impairment methodology, would entail the exercise of considerable judgement by banks. After lengthy deliberations, the International Accounting Standards Board (IASB) published the complete version of IFRS 9 Financial Instruments, which replaces most of the guidance in IAS 39.
For banks operating in Nigeria, where skills are scarce and the management of credit risk is less sophisticated, the implementation of the new standards will come with significant challenges. Unlike their international peers, many banks in Nigeria are seen to have very limited empirical data, if any, that can be used to estimate the future expected performance of their current portfolios.
“What to expect in IFRS 9 regime are around: classification and measurement; impairment testing and hedging. It is going to be a wide ranging impact that can fundamentally change a bank’s balance sheet,” Innocent Okwuosa, a senior lecture in Accounting and Finance, with Hertfordshire Business School, University of Hertfordshire told BusinessDay.
Okwuosa told BusinessDay that the greatest impact of IFRS 9 will be around loan loss provisioning and impairment testing. “Even here in the UK, the banks are gripped with fear of IFRS 9 implementation. Loan loss provisioning will be a nightmare for them. I am not sure what Nigerian banks will do as I guess the scenarios that can be simulated in the Nigeria situation will definitely be more complex, given the attitude of Nigerian borrowers.
“IFRS 9 establishes a new model for recognition and measurement of impairment, now known as expected credit loss model, as opposed to incurred loss model of IAS 39. The implication is that banks will now be expected to start providing for possible future credit losses in the very first reporting period that the loan has been booked in the bank’s financial statements.
“Expected credit losses are calculated by identifying scenarios that will result in a borrower defaulting and estimating what amount of loss will arise in each scenario. You can imagine the kind and amount of simulation that can go into such exercise. It is a complex situation and even in the UK, with the sophisticated and hands on experience and knowledge, the banks are like who will go first?
“First on classification and measurement, IFRS 9 simplifies classification of financial assets into two broad categories –amortised cost and fair value, according to the bank’s business model for holding such assets. So the bank first needs to define its business model, how it collects contractual cash flows from the assets.
If we reduce it to our accounting language IAS 39 that IFRS 9 is replacing could be likened to a rule based accounting, while IFRS 9 is principle based”, said Okwuosa, who also is a former lecturer in accounting with Henley Business School, University of Reading; and currently a council member of both the Institute of Chartered Accountants of Nigeria (ICAN), and Chartered Institute of Bankers of Nigeria (CIBN).
Since May 2017, banks have in line with the direction of the Central Bank of Nigeria (CBN) directorate of banking supervision guidance, been submitting their monthly status updates on the IFRS-9 implementation projects.
“The requirements of IFRS 9 offer financial institutions (FIs) an opportunity to improve on the level of sophistication of valuation models that are being used. In our view there are challenges we envisage that financial reporters would have to grapple with as Nigeria moves closer to the IFRS 9 adoption deadline”, said a team of financial services experts at PwC Nigeria. The challenges range from technical to operational, they noted.
They however believe that the requirements of IFRS 9 present an opportunity for the banks to improve on the level of sophistication of models and the granularity of data used for credit risk management and impairment accounting.
“The IFRS 9 standard dealing with impairment requires the recognition of credit losses based on expected credit losses –either 12-month or lifetime expected credit losses for: amortised cost assets, debt instruments at fair value through other comprehensive income (FVOCI) and loan commitments and financial guarantees”, according to PwC.
Accordingly, PwC expects to see significant changes in the current governance structures of banks, adding that as the level of judgment in these impairment models increases, so will the need for strong and robust governance processes to challenge the assumptions and decisions made to ensure that the final answer is not only correct, but also aligns with the business model. “It is expected that the IFRS 9 models will make increased use of judgment. The models used to support these judgements will therefore also be subject to a lot more scrutiny due to the large potential impact these models could have.”
BusinessDay sources at the Financial Reporting Council of Nigeria (FRCN) confirmed their willingness to assist banks to achieve seamless transition to IFRS-9.
One source said on phone, “We align with the IASB and don’t have a different position on implementation date for IFRS 9. Banks have to comply with the directives. But we are ready to help them through training, to ensure they don’t make mistakes.”
Iheanyi Nwachukwu & David Ibemere