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EBA mulls benchmarking exercise to test EU banks' application of IFRS 9


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According to Market Intelligence, April 2023

EBA mulls benchmarking exercise to test EU banks' application of IFRS 9

As a follow-up to the implementation of the new International Financial Reporting Standard at EU banks, the European Banking Authority wants to develop benchmarks that ensure a harmonized application of the rules.

The IFRS 9 standard came into effect Jan. 1 and introduced a new model of reporting based on expected, rather than already incurred, losses on financial assets. The implementation of the standard was expected to hit the core capital ratios of banks and lead to higher provisions.

Post-implementation review

In its first post-implementation review, based on actual data from bank reports and not estimates, released Dec. 20, the EBA found that on a simple average the negative day-one impact of IFRS 9 on the common equity Tier 1 ratios of the sampled EU banks was 51 basis points, a little above but broadly in line with the 42 basis points estimated in the EBA's last pre-implementation review in July 2017.

Nevertheless, the gap in CET1 impact between banks using the standardized approach for measuring counterparty credit risk, or SA banks, and those using internal ratings-based approach, or IRB banks, was wider than initially expected.

On simple average, IRB banks posted a mere 19 basis-point decline in their fully loaded CET1 ratios while SA banks incurred a 157 basis-point average blow, the EBA post-implementation review shows. This compares to the estimated average 32 basis-point drop in IRB bank CET1 ratios and a 77 basis-point drop for SA banks in the July review. The bigger impact for SA banks mainly stems from the way they calculate regulatory expected losses, because unlike IRB banks those are not already included in their CET1 ratios.

Provision levels, which were expected to substantially increase as a result of IFRS 9, rose by 9% on simple average, a smaller increase than the July estimate of 13%, the EBA found. On average, IRB banks had to make higher provisions than SA banks. The increase in provisions is because under the new standard, banks have to account for expected losses on all of their financial assets, not just nonperforming assets. Therefore, banks need to estimate and provide for the potential losses on a loan at its origination and not only when there is a realized impairment of that loan.

Follow-up implementation measures

The preliminary review of post-IFRS 9 implementation data highlights the importance of follow-up monitoring of the application of the rules, according to the EBA.

"The challenge for regulators and supervisors is to ensure a high-quality and consistent implementation of the standard, since the outcome of the [expected credit loss] calculation will directly impact the amount of own funds and the regulatory ratios," the EBA said.

Therefore, one of the main areas the EBA wants to focus on in the future is modelling at IRB and SA banks to see how they use it to make their expected credit loss, or ECL, estimates.

The authority wants to ensure that the use of different methodologies, models, inputs and scenarios does not lead to a wide diversion in the calculation of expected losses at EU banks. Therefore it is considering the launch of a benchmarking exercise in the medium- to long-term.

For 2019, the EBA plans to further investigate the use of macroeconomic scenarios and variables at IRB banks to estimate ECL and and the way these banks are building databases and managing data shortages. At SA banks, the regulator wants to further probe aspects relating to the main simplifications used for ECL modelling, "including proxies and overlays considered by the banks," the EBA said.

It also noted that given the SA banks' "generally lesser modelling experience" it would pay greater attention to them than to IRB banks in its investigation.