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IFRS 9 replaces the incurred loss model of IAS 39 with a forward-looking expected loss model, under which credit loss provisions are equal to the expected credit losses. The expected loss model is likely to increase credit loss charges for banks, reducing after-tax profits, and, hence retained earnings; the main source of equity capital of banks. Thus, to maintain their capital ratios, banks may choose to hold higher levels of equity capital under IFRS 9. To estimate the impact of this IFRS 9-induced potential increase in equity capital on the cost of funding of banks, authors followed Baker and Wurgler (2015) by adjusting CAPM to account for the low-risk anomaly.
Consistent with past literature, authors confirm that the low-risk anomaly exists for bank equity in the UK, Germany, Italy, Spain and Switzerland. However, the results do not provide a robust evidence of the anomaly for French banks’ equity. The annual magnitude of the anomaly varies across countries, but is generally low relative to the long-run cost of equity for banks. They show that the implementation of IFRS 9 may slightly increase the cost of funding for banks in the six countries except France, where the cost of funding for banks could fall.
Whether this impact can be viewed as an estimate of the longer-term impact of IFRS 9 depends on two elements, which are out of the scope of author’s analysis. First, they did not investigate whether the impact of IFRS 9 on the level of equity capital would be stable across different stages of the credit cycle.
Likewise, they did not account for the potential positive effects of the early recognition of losses under IFRS 9 on asset quality transparency. An increase in this transparency might reduce (or increase) the cost of equity and debt for banks at different levels of leverage. In this case, their estimates would have overstated the impact of IFRS 9. Nevertheless, their analysis provides important insights about the potential implications of IFRS 9 on the cost of funding of banks. It also represents a good start for similar analyses in the future when IFRS 9 becomes more established.
Full working paper on Bank of England