Effective for annual periods beginning on or after January 1, 2018, IFRS 9 set out how banks should classify and measure financial assets and financial liabilities. Its scope includes the recognition of impairment. In the standard that preceded IFRS 9, the “incurred loss” framework required banks to recognise credit losses only when evidence of a loss was apparent.
Under IFRS 9’s expected credit loss (ECL) impairment framework, banks are required to recognise ECLs at all times, taking into account past events, current conditions and forecast information, and to update the amount of ECLs recognised at each reporting date to reflect changes in an asset’s credit risk. It is a more forward-looking approach than its predecessor and will result in more timely recognition of credit losses and a likely increase in NPLs.
Bank’s IFRS 9 disclosures reveal its Stage 2 loans. According to S&P, on average, Stage 2 loans comprised 10.6 per cent of total loans for rated banks. The rating agency expects smaller banks to experience greater deterioration in asset quality as large banks typically have conservative risk management practices and are selective in their lending. Write-offs increased almost everywhere because banks wanted the ratio of Stage 3 loans after the transition to IFRS 9 to be similar to the ratio of NPLs under previous standards (IAS 39) before it. The biggestincrease was in Qatar and the UAE because of high write-offs at a few banks
“We expect the total amount of loans at either Stage 2 or Stage 3 to remain stable at around 15 per cent of total loans over the next 12-24 months. However, we could see more loans migrating to Stage 3 from Stage 2 and banks pursuing more-aggressive write-off practices,” said Damak.
Stages of loan loss recognition
Under the ECL framework impairment of loans are recognised under three stages.
Stage 1: When a loan is originated or purchased, ECLs resulting from default events that are possible within the next 12 months are recognised (12-month ECL) and a loss allowance is established. On subsequent reporting dates, 12-month ECL also applies to existing loans with no significant increase in credit risk since their initial recognition.
Stage 2: If a loan’s credit risk has increased significantly since initial recognition and is not considered low, lifetime ECLs are recognised. The calculation of interest revenue is the same as for Stage 1.
Stage 3: If the loan’s credit risk increases to the point where it is considered credit-impaired, interest revenue is calculated based on the loan’s amortised cost (that is, the gross carrying amount less the loss allowance). Lifetime ECLs are recognised, as in Stage 2. Twelve-month versus lifetime expected credit losses ECLs reflect management’s expectations of shortfalls in the collection of contractual cash flows.