EBA opinion on IFRS 9 and the impact on regulatory capital

After the Basel Committee consultation in October and then the European Commission’s legislative proposal of the package CRR II / CRD V in November 2016, the EBA has now given its opinion on the management impact of IFRS 9 on regulatory capital, notwithstanding a second impact study has just been completed.

This opinion, primarily addressed to the European Commission, the European Parliament and the European Council, first recalls the treatment proposed by the European Commission in CRR II (Article 473a) for managing the impact of IFRS 9 Phase 2 (provisioning), namely:

– The observation of a transitional period of 5 years from January 1st 2019, i.e. one year after the entry into force of the new accounting standard;

– The total neutralisation of the IFRS 9 Phase 2 impact on regulatory capital in 2018 in the CET1 capital (core capital);

– The digressive neutralisation of the accounting ECLs for buckets 1 (performing loans) and 2 (outstanding loans suffering significant deterioration), or even bucket 3 (doubtful loans) based on understanding of the said article; and

– The consideration of a “dynamic” effect with an impact update annually, based on the actual amount of ECL accounting.

In addition, the EBA takes a position on structuring elements concerning regulatory capital, proposing:

– The reduction of the transitional period to 4 years to be in line with the transitional period observed since 2014 for the filters and prudential deductions (out of exceptions);

– All IFRS 9 ECLs be treated as specific provisions, considering that these provisions are not freely and fully available as recommended in the definition of general provisions, which has a potentially significant impact on entities applying the standardised approach in credit risk (no more add-on related to standardised general credit risk adjustments in Tier 2 capital and the negative net effect of the new provisioning IFRS 9, the decrease in the EAD and therefore in the RWA being not offset by the CET1 capital loss); and

– A “static” approach to neutralise the impact in CET1 capital in order to fix the FTA impact (First Time Application), while highlighting the disadvantage of not taking into account the evolution of the portfolio.

Furthermore, the EBA deplores the fact that only the impact of Phase 2 is currently being considered by the Basel Committee and the European Commission, considering that the overall impact of the new standard should be considered.

Finally, for entities using internal models, it is still difficult to get a clear idea of the impact on regulatory capital due to the level of prudential EL, although the results of the second impact study expected in the second quarter of 2017 should provide clarification. In any event, the EBA raises a “bias” in the European Commission’s proposal, i.e. the lack of consideration of the excess or shortfall of prudential EL before the changeover to IFRS 9, which makes “false” the proposed transitional impact to the risk of artificially increasing the CET1 capital.

While it’s barely nine months before the standard comes into force and at a time when there is increasing tightness in the banking system, the publication of this opinion should help to advance the debate, which furthermore was discussed by the Basel Committee on 1 and 2 March.

Article written by Audrey Cauchet & Othmane Kanouni