IFRS 9 loan loss provisioning faces its first real test

My long held view has been that IFSR 9 adds to the procyclicality of the banking system (see here, here, and here) and that the answer to this aspect of procyclicality lies in the way that capital buffers interact with loan loss provisioning (here, here, and here).

So it was interesting to see an article in the Financial Times overnight headlined “New accounting rules pose threat to banks amid virus outbreak”. The headline may be a bit dramatic but it does draw attention to the IFRS 9 problem I have been concerned with for some time.

The article notes signs of a backlash against the accounting rules with the Association of German Banks lobbying for a “more flexible handling” of risk provisions under IFRS 9 and warning that the accounting requirements could “massively amplify” the impact of the crisis. I agree that the potential exists to amplify the crisis but also side with an unnamed “European banking executive” quoted in the article saying “IFRS 9, I hate it as a rule, but relaxing accounting standards in a crisis just doesn’t look right”.

There may be some scope for flexibility in the application of the accounting standards (not my area of expertise) but that looks to me like a dangerous and slippery path to tread. The better option is for flexibility in the capital requirements, capital buffers in particular. What we are experiencing is exactly the kind of adverse scenario that capital buffers are intended to absorb and so we should expect them to decline as loan loss provisions increase and revenue declines. More importantly we should be seeing this as a sign that the extra capital put in place post the GFC is performing its assigned task and not a sign, in and of itself, indicating distress.

This experience will also hopefully reinforce the case for ensuring that the default position is that the Counter Cyclical Capital Buffer be in place well before there are any signs that it might be required. APRA announced that it was looking at this policy in an announcement in December 2019 but sadly has not had the opportunity to fully explore the policy initiative and implement it.

Tony