BY NBM WRITER
The final days of 2017 are finally here with us and no one can say it hasn’t been an eventful year. From several natural disasters hitting all over the world to one of the most prolonged electioneering periods within our country. Even though the world was full of different events, let us focus on events affecting one sector that has really seen some crucial changes, the financial sector.
Different events took place in the financial sector. In kenya for instance, a lot happened, from the launch of the first mobile sovereign bond in the world to the coming into law of the interest rate cap. These events changed the norm that was there in the financial sector, receiving mixed reactions from the public. Now as the year comes to an end and people reminisce, they should also start preparing for the next year which starts off with another major change in the financial sector.
Come January 1st 2018, the new reporting standard, IFRS 9 Financial Instruments, which was established by the International Accounting Standards Board (IASB), takes full effect replacing the current standard, the IAS 39. These standards are the guidelines responsible for ensuring that financial statements are fairly and consistently presented to describe the true financial performance of companies. The IAS 39, which was put forward in 2001 was to address the recognition and measurement of financial instruments, hedging transactions and derecognition rules of financial assets and liabilities.
However, once it came into effect in 2005 it was regraded to be too complex, full of inconsistencies and having many exceptions causing companies to struggle to adhere to the standard. For example, organizations had to pay large sums of money to consultants in order to apply the standard correctly. In addition, according to a report done in 2009, the standard was found to be partially responsible for causing the financial crisis.
As a result, the IASB and its American counterpart; the Financial Accounting Standards Board (FASB) started a joint project to revise their accounting standards. However, after disagreeing on a few issues, the two boards took different directions and as a result the IASB came up with the IFRS 9. It took a while to finalize the project but in 2014 the final complete IFRS 9 was eventually issued and institutions were given up to the first day of 2018 to make the switch.
The IFRS 9 is expected to change the way financial institutions classify and measure financial assets and liabilities, reform hedge accounting and introduce a model for impairments. It will mostly be dealing with the accounting for financial instruments like government securities, loans and advances, customer deposits, debtors and creditors.
This new standard will require financial institutions to classify their financial assets in four categories; amortized cost, fair value through profit and loss (FVTPL), fair value through other comprehensive income (FVTOCI) for debt and FVTOCI for equity. This will be simplified compared to the IAS 39 requirements that classify financial assets as held to maturity (HTM), loans and receivables (LAR), fair value through profit or loss (FVTPL) or available for sale (AFS) with the first two being measured at an amortized cost while the rest were measured at fair value.
As the categories change, new classification rules will also come up with the new standard come January. For example, even though equity investments and derivatives are usually measured at fair value, classifying them in FVTPL, the new standard will allow some equity investments that are not for trading to be classified as FVTOCI.
Apart from this, the classification of non-equity assets will now also depend on either the financial asset’s business model or its contractual cash flow. The IFRS 9 will thus be doing away with the current standard requirement on identifying and separating embedded derivatives. Alternatively, it will now require institutions to determine the classification based on the financial asset as a whole.
IFRS 9 is also going to change the current model of impairment. Under IAS 39 an entity was able to only recognize a credit risk whenever the borrower would default. For example, If Mutua was to borrow some money from a bank, the bank was only able to make a provision for his loan when he showed signs of stress, such as missing to make payment for a month, to repay the loan.
However, this is about to change as the IFRS 9 introduces the new expected credit loss (ECL) model which broadens the information that an institution is expected to consider in terms of impairment. The new model will require entities to take into account future events and thus they will have to make a provision for the loan given from the beginning and during its entire credit life cycle regardless of whether the borrower shows any signs of stress. This will end up causing an increase in instances where institutions have book figures showing less profit and more losses.
In addition, the new standard also changes the rules on the provision for impairment. This will have a major impact on the customer as unlike under IAS 39 where an entity looked at every facility that a customer had, such as a credit card, letters of credit, personal loan or overdraft, separately. In IFRS 9 the institutions will not look at this facility’s separately but they will have all this information under the customer in what is known as cross-product default. Therefore, if one has no defaults and pays on time they will be able to get better rates but for the case of one with defaults it means that institutions will have to impair the other products the customer has.
The IFRS 9 is also expected to bring about a new relationship between institutions and regulators. This will especially affect banking institutions that will now have to come up with three reports. This will not only be difficult for banks but it will be costly as well. During the IFRS 9 workshop in Nairobi, Yusuf Omari, Chief Financial Officer (CFO) at Barclays Bank of Kenya said, “The main challenge and cost of the new standard will be preparing for three sets of accounts for impairment – one for Central Bank of Kenya (CBK), Kenya Revenue Authority (KRA) and IFRS9.”
Institutions and regulators had since 2014 to prepare for the new IFRS 9 standard and it is good that most of them are at a satisfactory stage in terms of getting ready for next year. However, this seems to only be the case for top banks and banks with global parentage as other local banks are still lagging behind. Apart from this, organizations need to stop thinking this will only affect financial institutions and start getting ready as it will affect them as well. Whether institutions and organizations are ready for the change from IAS 39 to IFRS 9 or not, only time will tell. The only advice that can be bestowed is that everyone needs to be ready for the new norm in the financial sector.
