In the backdrop of the buzz that IFRS 9 has generated in the banking industry, and to demystify IFRS 9

principles, Aptivaa is pleased to launch a series of blogs to apprise readers of some of the key aspects

related mostly to impairment modeling, for compliance with the new accounting standards, as well as

to have a conversation with the readers about the challenges that banks are facing in their

implementation efforts.

On 24 July 2014, IASB issued the fourth and final version of its new accounting standard – IFRS 9

Financial Instruments, which replaces most of the rule-based standards of IAS 39 with principle-

based guidance. IFRS 9 is built on a logical, single classification and measurement approach for

financial assets that reflects the business model in which they are managed and their cash flow

characteristics.

The fundamental shift from IAS 39 to IFRS 9 standards is “Incurred Loss Approach” to “Forward-looking

Expected Loss Approach” for impairment assessment. In the past, accountants were not comfortable

with accounting based on “expected” outcome unless they have “sufficient proof” to believe so; due to

which loan loss provisioning was 'too little, too late'. The fundamental responsibility of accounting is to

ensure “True and accurate Representation” of accounts in P&L statement. Given this background, IFRS

9 is a fundamental shift in mindset.

The Standard also includes an improved hedge accounting model to improve the link between the

economics of risk management with its accounting treatment.

From IAS 39 to IFRS 9

ISSUE 01

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IFRS 9 principle comprises of three structured components:

A successful implementation of IFRS 9 is predicated on the successful and the close coordination between Risk

and Finance teams within a bank and the proverbial 'breaking of the silos' is paramount. Banks that approach

an implementation in silos is likely to run into considerable problems at a later stage.

Many banks in emerging markets have asset allocations that are relatively non-complex and not subject to

dynamic changes. This simplifies identification of business models for Asset classification, but the same

reasons call for extensive credit risk modelling efforts for impairment calculations. Hence, Impairment modeling

is one of the core areas where banks need to focus.

IFRS 9 will be effective for annual periods beginning on or after January 1, 2018, subject to endorsement in

certain territories; therefore considering the complexity of changes in systems, processes, and data

requirements, Banks would require minimum of two years of implementation and a parallel run to ensure the

readiness for 2018.

In the coming week, we will be discussing the Building blocks of impairment modeling. The post will aim to

broadly cover the understanding of core components of ECL measurement and challenges related to each

component in detail.

This space aims to answer your queries pertaining to IFRS 9 principles. In case, you have any queries

pertaining to IFRS 9 which you wish to discuss, do leave your comments.

As a part of IFRS 9 series, we will be touching upon the following topics in the coming weeks

Ÿ BCBS expectations of high quality implementation of IFRS 9 standards

Ÿ The loss rate approach and how is it different from a PD/LGD approach

Ÿ The master rating scale and its applicability

Ÿ Distinction between PD and historical default rate

Ÿ Distinction between TTC PD and PIT PD

Ÿ Identifying different stages of impairment model

Ÿ PD calibration methodology and its significance in/for ECL measurement

Ÿ Characteristics of LGD parameter in Risk Models and its distinction from expected cash shortfall

Ÿ EAD and its use, and how is it different from ‘current outstanding’ exposure

Ÿ Lifetime expected credit loss and why it is not a simple multiplication of lifetime PD and LGD

Ÿ Key requirements for validation and governance framework, and many other key areas related to impairment modeling

We expect that these discussions, with feedback from our clients and associates, will help our readers in demystifying various

principles of IFRS 9 impairment modeling.

Introduction of new measurement category:

‘Fair Value through other comprehensive

Income’ (FVOCI)

‘Tainting rule’ has ceased to exist in IFRS 9 –

i.e., sales of ‘held to maturity’ assets under

IAS 39 before maturity jeopardize amortized

cost accounting for entire portfolio

Classification of instruments are now based on -

Ÿ Entity’s Business Model

Ÿ Contractual Cash flow characteristics test

(SPPI)

Classification & Measurement01

COMPONENT

ECL model is applicable for instruments

classified under Amortized Cost and FVOCI

(debt instruments) category

Recognizes 12-month loss allowance at initial

recognition and lifetime loss allowances on

significant increase in credit risk

IFRS 9 replaces IAS 39 ‘Incurred Loss’ Model

with new Forward looking Expected Credit

Loss (ECL) model

Requires incorporation of forward-looking

information in ECL estimates

Introduction of new hedge accounting model

The 80-125% hedge effectiveness testing

ratio range is replaced by an objectives-

based test that focuses on the economic

relationship

Simplified hedge accounting rules to reflect

more accurately how an entity manages its risk

More designations of groups of items as the

hedged items are possible under new rules

Impairment02COMPONENT

Hedge Accounting03COMPONENT

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