IASB finds that IFRS 9’s impairment requirements are working well

After six years of IFRS 9, during which it has been significantly tested by Covid-19 and the cost-of-living crisis, the IASB has found the impairment requirements of the standard to be working as intended.

Background

IFRS 9 was implemented in 2014 as the accounting response to the 2007/09 global financial crisis. Notably, it replaced the ‘incurred loss’ impairment model of IAS 39 with a more forward-looking ‘expected loss’ model, to respond to the criticism that impairment losses under IAS 39 were not recognised early enough.

In 2022, the IASB commenced a post-implementation review of the impairment requirements of IFRS 9 and, on 4 July 2024, it published its findings.

The post implementation review included meeting a wide range of stakeholders, a review of academic literature, academic research and a written call for evidence. While 79 comment letters were received, mainly from preparers, standard setters, and accounting firms, there was only one response from users of financial statements. The responses had a global reach, although the majority were from Europe and Asia-Oceania.

But IFRS 9 covers more than just impairments: the IASB has already completed a post implementation review of the classification and measurement requirements of the standard; next it will review the hedging requirements.

IASB findings

Overall, the IASB concluded that the impairment requirements in IFRS 9 are working as intended and that there are no fatal flaws with the standard. This was also the view of ICAEW in its response to the IASB’s call for evidence.

The IASB also noted that, “in general, the requirements can be applied consistently; the benefits to users of financial statements from the information arising from applying the impairment requirements in IFRS 9 are not significantly lower than expected; the costs of applying the impairment requirements and auditing and enforcing their application are not significantly greater than expected”.

With no significant concerns about the impairment requirements in IFRS 9, the IASB has completed its post-implementation review and will not undertake any further work on impairments.
The IASB did, however, find some concerns with the consistency of application of the standard. In response, a new project has been added to the IASB’s workplan to look at the credit risk disclosure requirements in IFRS 7 Financial Instruments: Disclosures. The intent is to make targeted improvements that enhance the usefulness of the credit risk disclosures.
The IASB will also consider the interaction of impairments with modification, derecognition and write-offs as part of its Amortised Cost Measurement Project.

Observations

Overall, the IASB reported (page 22) that “Most stakeholders said that the application of the impairment requirements during periods of economic crisis, such as the covid-19 pandemic, showed that the principles in IFRS 9 are robust and capable of representing changes in economic conditions and circumstances.” In our response, (likewise UK Finance and others), we noted that the standard has not yet been tested by a conventional recession. The unprecedented levels of government support during the Covid-19 crisis meant arrears and defaults associated with a conventional recession were not experienced. As a result, while there is nothing to suggest that IFRS 9 will not perform as intended, the standard has yet to be fully tested and we should not be complacent that the impairment requirements of the standards might not yet need changing. The IASB will need to keep the standard under review for a while longer.

While the IASB proposes no changes to the standard, the feedback did raise a number of concerns. Notably, that in practice, there are different approaches to estimating credit losses and there is diversity in the volume and quality of disclosures made. Areas of concern include, determining when a significant increase in credit risk has occurred, the use of post model adjustments, and the use of forward-looking scenarios (eg, number of scenarios, their nature, severity and weightings).

When banks adopt different approaches or make different disclosures it impedes the ability to compare their credit risk exposures and how they manage credit risk: individual banks cannot be benchmarked against their peers. When benchmarking is possible, it can lead to greater consistency when it highlights that different approaches are taken for the same credit risk.
Poor quality disclosures hinder comparison but can also a mean that a bank’s credit risk exposures and credit risk management are opaque. Users cannot understand the extent of the credit risk being run, how the risk is being managed, and whether the management of the risk is effective in mitigating the risk in line with a bank’s risk appetite.

In part the concerns are due to the nature of the standard, which is principles based and designed to enable an individual bank to report credit risk in its financial statements in a way that best reflects how it actually manages credit risk. In practice banks have adopted a diversity of approaches to manage their credit risk, which the standard needs to accommodate.

Expected credit losses are also estimates that entail assumptions and judgements about how to forecast and model an uncertain future. Different banks may make different assumptions and judgements. Some judgments may be more soundly made than others, but a range of different judgments may equally be reasonable. Moreover, there can be a complex interplay between different judgements, so that same overall outcome (eg, expected lifetime credit loss) may be achieved by different sets of judgements. The judgements will also reflect the extent to which the credit exposures are material in the context of an individual bank’s financial statements, and the availability of reasonable supportable evidence.

While it is perhaps not desirable or possible to achieve consistency for all components that go into determining the estimate, it is nevertheless important that there is a consistent clear understanding of the accounting objective or purpose, and that certain tenets are well defined (eg, that the expected credit loss is a probability weighted average, rather than defining the number of scenarios or weightings; or to be clear what is meant by a ‘significant’ increase in credit risk). High quality disclosures are important in this regard, to ensure there is sufficient transparency of the approaches adopted and how they implement the standard’s objectives and requirements.

The danger, if the accounting standard were to impose more prescriptive estimation methodologies to deal with the concerns, is that it distorts and misrepresents actual risk management practices and imposes a single set of judgements when others may also be appropriate (the standard should not be the tail that wags the dog).

Targeted changes to the credit risk disclosures that enhance users’ understanding of a bank’s risks are to be supported. A better understanding of an individual bank’s credit risk should also promote improved comparability and may drive greater consistency in approach between similar exposures.

We would note, however, that more disclosure is not always the answer, as it increases the risk that the trees obscure the wood. And as the IASB notes, more disclosures may be burdensome for some. So “targeted disclosures”, as the IASB indicates, should be the order of the day, and the hurdle to justify more disclosures should not be unduly low.

As noted above, as the standard has yet to be tested by a conventional economic recession or stress scenario, it may also be premature to contemplate changes to the approaches to calculate the estimate. So, a wait and see approach may be the appropriate stance at this time – wait for a more conventional recession and for any new targeted disclosures to embed and see what effect they have. There is maybe also a role for the auditors to drive consistency in approach, where appropriate.

Finally, users of financial statements need to be clear what their needs are. At present there is a perception that a significant driver of approaches or disclosures is the prudential regulator. The regulator is an important and very interested stakeholder given the importance of credit losses to banks’ prudential soundness; and it has an unrivalled expertise to bring to the debate. The regulator, however, has a particular set of objectives to meet, which may not always align with the market and the purpose of international financial reporting standards. For example, the regulator’s approach may encourage greater prudence and procyclicality than justified over a short time horizon.