Practical Challenges Presented by IFRS 9 Compliance

Published: Jan 22, 2021

Issued in July 2014, IFRS 9 is an International Financial Reporting Standard (IFRS) published by the International Accounting Standards Board (IASB). This standard replaced IAS 39, also known as Financial Instruments: Recognition and Measurement. The shift from IAS 39 to IFRS 9 came about as a response to criticisms that the former is too complex and presents too many inconsistencies. 

IFRS 9 is developed in three phases, which also serve as the standard’s focus. These are the classification and measurement of financial instruments, impairment of financial assets, and hedge accounting. The standard is built upon the concept of measuring and classifying financial assets at fair value, with all changes in fair value reported in profit and loss (FVPL). The only exception to this is if the financial asset qualifies for the restrictive criteria wherein it can be measured as either Fair Value Through Other Comprehensive Income (FVOCI) or Amortized Cost. In short, IFRS 9 offers a simpler model compared to its predecessor, but at the cost of volatility in profit and loss. 

Reconsidering the provisions of IAS 39 has always been on the agenda of the IASB, but the task became a priority as a result of the 2008 financial crisis. IFRS 9 came into force at the start of 2018, though some have been using it before then. Also, a few entities with predominantly insurance-related activities have been granted the option to delay its implementation until 2021. These days, a good number of financial institutions depend on IFRS 9 applications and solutions to ensure their company’s compliance. 

Compliance Challenges

To put it simply, the IFRS is the de facto standard for financial reporting. Complying with these standards, as a whole, offers business benefits to financial institutions. At the same time, the implementation of IFRS 9 adds to the heavy cost and painstaking requirements that banks have to deal with to comply with regulatory bodies. In particular, IFRS 9 presents the following challenges to banks and other entities that make up the financial sector:

Classification and Measurement

Under the standard, financial instruments can only be classified into three types: FVPL, FVOCI, and Amortized Cost. Their classification determines how the financial instruments are recorded and valued. The limited choice of options, however, doesn’t mean that the classification process will be an easy one. To set a foundation for consistent valuation and classification, financial institutions must understand the rules for each class, thoroughly review their assets, and assess how they manage their loans and accounts receivables. 

Risk Management Strategies

The way financial instruments are classified can have a significant effect on business model management and how companies manage their capital. IFRS 9 generates more volatility and negatively impacts net income and equity. In preparation for the new standard, financial institutions should evaluate the strategies and financial instruments that they use to manage risks. This, in turn, will help them make informed decisions in terms of restructuring and repositioning the company. 

Data and Modeling

IFRS 9 uses a forward-looking approach that requires more historical and risk data than IAS 39. This can be a significant hurdle when it comes to Expected Credit Loss (ECL) modeling. The standard requires credit risk reevaluation after each balance sheet date to ensure that changes in credit risk and loss are accounted for. This is a task that requires a lot of resources and improved communication channels between the finance and risk departments. The financial institution must also use an ECL modeling system that is capable of applying the expected loss methodology they use to assets that belong to different classifications.

Processes and IT Systems

The financial institution’s IT systems must make room for adjustments as well. During the implementation stage, the IT department must contend with the task of ensuring data quality and availability as well as adapting to new processes, systems, and modeling tools. Aside from this, the team should also prepare to accommodate possible organizational changes that the company needs to make in preparation for the new accounting standard.  

Product Lines

Banks may need to reconsider their product offerings, as the implementation of IFRS 9 may render some of their products unprofitable. In preparation for this, financial institutions must evaluate the strategic impact of IFRS 9 on their current offerings and have plans in place to communicate these changes with their clients.  

Benefits Presented by IFRS 9

At the end of the day, IFRS 9 is meant to augment the efficiency of the banking system. In particular, it is designed to avert another financial crisis and protect the interest of the general public as well as the shareholders of the financial institution. Facing the challenges brought about by IFRS 9 compliance head-on gives banks a better understanding of the risks that are inherent in the business. This, in turn, will provide them with more opportunities to make better business decisions, address and mitigate risks, and work together to build a more resilient and low-risk financial system.