EBA欧洲银行-Session-3-Slides-J.-Abad2C20J.-Suarez_25页_333kb

Summary of "Assessing the cyclical implications of IFRS9: A recursive model"

Core Content

IFRS 9 is a new accounting standard for financial assets, effective from 1 January 2018. It replaces the previous incurred loss (IL) approach with an expected loss (EL) approach for loan loss provisioning. This change is designed to improve the timeliness and accuracy of credit loss recognition, aligning with the US GAAP CECL model, which was introduced in 2021.

The standard introduces a mixed-horizon approach for impairment calculations:

• Stage 1 loans (non-deteriorated) are subject to one-year EL.
• Stage 2 loans (deteriorated) are subject to lifetime EL.
• Stage 3 loans (impaired) are subject to lifetime EL, similar to IAS 39.

The study investigates the cyclical implications of IFRS 9, focusing on how it might affect banks' profit and loss (P/L), CET1 capital, and ultimately credit supply. The key concern is that the more forward-looking nature of EL provisions may lead to procyclical effects, exacerbating credit contractions at the onset of economic downturns.

Main Viewpoints

• Reactivity to Economic Conditions: IFRS 9's EL provisions are more sensitive to economic changes than the IL approach, leading to larger on-impact effects of negative shocks.
• Impact on Bank Capital: Under IFRS 9, a typical recession can reduce CET1 capital by about 1/3 of fully loaded CCB, which is twice as much as under the IL approach.
• Recapitalization Probability: Banks are more likely to need recapitalization under IFRS 9, especially during contraction periods.
• Procyclical Effects: The impact is more pronounced during longer or deeper crises, and less so if the crisis is anticipated in advance.

Key Information

• Model Overview: The study uses a recursive ratings-migration model with random maturities to simulate the effects of IFRS 9.

• Calibration: The model is calibrated using a European corporate loan portfolio, incorporating data on rating migrations and defaults.

• Parameters:

  • Banks' discount rate: 1.8%
  • Persistence of expansion state: 6.75 years
  • Persistence of contraction state: 2 years
  • Migration rates vary with economic states (expansion vs. contraction).
  • Default rates and loss given default (LGD) are also state-dependent.

• Results:

  • IFRS 9 leads to higher volatility in P/L and CET1 compared to the IL approach.
  • Under IFRS 9, dividend payouts are more volatile, and recapitalization is more frequent during contractions.
  • The baseline results show that IFRS 9 provisions are more forward-looking, which increases the immediacy of loss recognition during downturns.

Implications

• Cyclical Effects: The more forward-looking nature of IFRS 9 could lead to more abrupt and severe reductions in bank capital during economic contractions, potentially worsening the credit crunch.
• Policy Considerations: The study raises questions about the worrying implications of such cyclical effects and suggests the need for macroprudential interventions.
  • Options include:
    • Focusing on implementation and relying on banks' voluntary buffers.
    • Using existing regulatory buffers (CCB and CCyB) with possible guidance revisions.
    • Enhancing stress testing to account for credit function preservation.
    • Updating regulatory capital definitions to reflect EL estimates.

Conclusion

IFRS 9 represents a paradigm shift in how credit losses are recognized, moving from a backward-looking to a forward-looking approach. While not a "killer" for the banking system, the procyclical nature of its provisions may lead to significant capital losses during downturns, increasing the likelihood of bank recapitalization. These effects may need to be monitored and mitigated through macroprudential policies to ensure the stability of credit supply.

Complementary Materials

• Portfolio Dynamics: The model uses a difference equation to track the evolution of loan portfolios over time:
  $$
  x_t = M x_{t-1} + e_t
  $$
  where $x_t$ represents the portfolio composition and $e_t$ is the new loan issuance.

• Loan Pricing: Loan rates are set to ensure zero net present value (NPV) of the loan, based on expected defaults and migrations.

• P/L and CET1 Dynamics: The P/L is influenced by:

  • Interest income and default losses.
  • Capital requirements and dividend policies.
  • Recapitalization decisions to maintain CET1 levels.

• Capital Rules: Banks use Basel III capital rules to manage CET1:

  • IRB banks: Minimum capital requirement is based on risk-weighted assets.
  • SA banks: Minimum capital requirement is a fixed percentage of risk-weighted assets.

• Sensitivity Analysis: The model shows that default rates and migration probabilities are sensitive to aggregate economic states, with higher rates during contractions.

Final Notes

The study highlights the complexity of assessing the real effects of IFRS 9, which is similar to the challenges in the literature on capital requirements. The potential negative welfare effects of early credit contractions may be offset by micro and macro-prudential benefits of earlier and broader loss recognition.