19 October 2018

ESMA: Better to be good and on time than perfect and late: replacing incurred loss by expected loss

IFRS 9 introduced a new progressive but complex accounting provisioning model that is at the forefront of interest not only of investors but also banking supervisors and accounting enforcers.

The change of the impairment model from the incurred loss to the expected loss marks a new paradigm. In his view, this change, at least partially, addresses the long acknowledged deficiency of accounting standards (“too little too late”) that manifested itself during the recent financial crisis and thus responds to the G20 mandate. This new paradigm allows earlier recognition of losses and considers a broader range of forward-looking information in accounting provisions. However, the new

provisioning model makes accounting for credit loss provisions more complex and introduces an additional layer of management judgment as well as discretion in estimating the forward-looking ECL. This increased complexity and reliance on judgments will pose additional challenges in assessing objectively the provisioning approaches by external auditors but also by banking supervisors and accounting enforcers.

He underlines that it is far too early for a definitive assessment of the overall impact of IFRS 9, both on financial statements and more broadly on security markets and the wider economy. This is because some of the effects can be observed only after a sufficient period of time has passed since initial implementation. The real evaluation of the ECL model will be possible only after the completion of a full economic cycle.

However, sound implementation and sufficient transparency on the assumptions are indispensable for the standard to operate as it was intended to. All actors need to work together and play their role: banks, auditors, supervisors: ensuring robust and consistent implementation of the new provisioning model as well as identification of any warning signs from its application.

Full speech

© ESMA