How Banks’ Switch To IFRS-9 Will Affect Loan Provisioning, Cost of Funds

By Nse Anthony-Uko
ABUJA, (Sundiata Post) – In barely four weeks from now, precisely from January 1, 2018, Deposit Money Banks (DMBs) in Nigeria are expected to switch over to the implementation of the International Financial Reporting Standard (IFRS-9).

The IFRS 9, promulgated by the International Accounting Standards Board (IASB) is expected to address the accounting for financial instruments particularly in the area of classification of assets and loan provisioning.

How will the implementation affect banks and customers?
While on the one hand, banks are faced with the possible negative consequences of making loan loss provisions as they gear-up for the adoption of IFRS-9, borrowers on the other hand, should brace-up for tougher credit processes as the IFRS-9 will only present the banks with more sophisticated ways of managing their credit risks.

IFRS-9 prescribes new guidelines for the classification and measurement of financial assets and liabilities, making fundamental changes to the methodology for measuring impairment losses by replacing the “incurred loss” methodology with a forward-looking “expected loss” model.
This means that banks must provide for losses before they are incurred.
Expected credit losses are calculated by identifying scenarios that will result in a borrower defaulting and estimating what amount of loss will arise in each scenario.
The Nigeria Deposit Insurance Corporation (NDIC) Director, Bank Examination Department, Mr Adedapo Adeleke, explained it thus, “As of today, what the banks provide for are losses that have been incurred. There are general provisions for other loans that are good which is about one per cent. But from next year January, if you make a loan today, let’s say for Adeleke, and Adeleke works for ABC Company, and the company is in some trouble and there is a risk that Adeleke may not be in employment over the next six months
And you have a loan that you are expected to make now that recoverable over the next two years, what IFRS 9 is saying is that you better provide for a portion of that loan at the moment you are creating it because Mr Adeleke may not be able to repay 20 per cent or 30 per cent of the loan that he is taking. So it’s expected loss and it’s going to have impact on provisioning by banks.”

How will IFRS-9 impact of bad loans?
Following the deterioration of the lenders’ capital in the past two years due to the recent recession, dollar shortage and exchange rate challenges, the banks’ capital has become eroded, causing the asset quality to decline.
The NDIC also predicted that the implementation of IFRS 9 may further impact on quality of banks’ assets as it will have significant impact on the volume of bad loans that banks would be required to make provision for.

This is expected to put more pressure on banks’ capital as the banks will need to use part of their profits to make provision for loans that are expected to become non-performing, after making provisions for those that are already non-performing.

In line with the CBN prudential guidelines, banks make provisions for non-performing loans after 90 days, 180 days and 360 days. But what the IFRS 9 is saying is that if you are expecting a loss, you need to be forward looking by making provision for that loss ahead.”

The NDIC Director, whose paper was entitled: “Curtailing the growth of NPLs in Banks: the role of regulators and supervisors,” disclosed that the Corporation was concerned about the rapid growth in NPLs in the banking industry in recent years

Though the CBN putting the regulatory maximum limit of NPLs that lenders are allowed to have on their books at five per cent, current data shows that the volume of bad loans in the banking industry has jumped from 11.12 per cent in 2015 to between 19 and 21 per cent in 2016, and to 15.18 per cent as at September 2017.

Adeleke said that the NDIC was disturbed by the fact that when the corporation’s examiners were coming out with a figure of about 20 per cent as the industry’s level of NPLs as at last year, the banks were still claiming that it was 10 per cent.

Analysts point out that Nigeria’s current economic woes, which were mainly triggered by the slump in oil prices in mid-2014 have resulted in a deterioration of asset quality and rising NPLs in the banking industry.

Banks’ huge exposure to the oil and gas sector has led to higher NPLs following the decline in oil price in 2014.

Although the situation has improved, there was a need for the banks to work harder on their capital as higher NPLs had caused erosion of capital and deterioration in their asset quality.

Since May 2017, banks have in line with the direction of the Central Bank of Nigeria (CBN) directorate of banking supervision guidance, been submitting their monthly status updates on the IFRS-9 implementation projects.

With the anticipated pressure that the IFRS 9 will put on banks’ capital and by extension, profitability, fund users expressed concern that this might push up the already high cost of borrowing from Nigerian banks.
They argue that banks would want to push all the extra costs incurred back to the customers and jack up the already high interest rates, thus making credit more expensive and difficult to access.
Commenting on this, Adeleke allayed such fears, stating that on the contrary, the adoption of the IFRS would boost competitiveness among financially institutions as they strive for the sustainability of their businesses.
He said, “The cost of doing business is part of what banks normally would put in the template to decide what interest rate they charge, but even if banks are oligopolistic in the sense that you have big banks that are competing, they are not monopolistic.
“So if one bank decides to increase its interest rate so high above the market rate it is likely that people will not go to that bank, will they go to other banks. So since the economy is competitively driven, this issue that one banks will set the interest rate that so high and punitive and people will not be able to have access to credit then it’s that bank that is running a risk of not being in business.
You have to be sustainable in business and this affects the kind of decisions that you must take regarding your business,” he said.

Though the implementation of IFRS 9 will lead to banks making higher provisioning, thereby reducing their capital and profitability in the short term, it is however expected to have significant impact on banks’ overall stability over the long term.

Analysts believe that the IFRS 9 will make banks’ balance sheet more resilient thus making the banks more attractive to foreign investors.

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