Financial Instruments

(Effective 1 January 2018)

What is the objective of IFRS9?

The objective of the International Financial Reporting Standard (IFRS9) is to establish principles for the financial reporting of financial assets and financial liabilities that will present relevant and useful information to users of financial statements for their assessment of the amounts, timing and uncertainty of an entity’s future cash flows.

 

What is new in IFRS9 compared to IAS39?

There are three (3) major areas:

  1. Classification and measurement of financial assets and financial liabilities. Financial assets are classified on the basis of the business model within which they are held and their contractual cash flow characteristics. The fair value option for financial liabilities was changed to address own credit risk. A “fair value through other comprehensive income” measurement category for particular simple debt instruments was introduced.
  2. Impairment methodology. The changes relate to accounting for an entity’s expected credit losses on its financial assets and commitments to extend credit. Under IFRS9, it is no longer necessary for a credit event to have occurred before credit losses are recognized.
  3. Hedge accounting. The changes align hedge accounting more closely with risk management, establish principles and addressed some gaps in hedge accounting that existed in IAS39.

 

What are the implications of IFRS9?

It is understood that IFRS9 will lead to an increase in credit loss/impairment provisions. According to surveys undertaken in Europe, 80% of the banks expect their retail and corporate credit impairments to rise. One in six banks project a 50% increase in credit impairment. This would have negative implications on profitability and capital adequacy ratios.

Our high-level methodology

 

How is Expected Credit Loss calculated?

Expected Credit Loss (ECL) is calculated for each loan or group using a number of parameters (i) probability of default (ii) loss given default (iii) exposure at default (iv) discount factor for lifetime cashflows using the effective interest rate. The probability of default can be derived using Bayes theorem, Markov chain or Weibull model, among others. During the design phase, the most suitable methodology will be selected and included in the construction of the ECL tools.

 

For more detailed information and inquiries:

Albert Richards Otete

Financial Services Partner

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+256 772 703444

Samuel Richards® & Associates

Regency Plaza, Lugogo Bypass

P O Box 22934 Kampala, Uganda

www.jsamuelrichards.com