03/01/2018
EFFECTS OF IFRS 9
On January 1st 2018, Kenya will join more than 120 other countries around the world in implementing a new set of global accounting guidelines. The new guidelines, which are technically referred to as the International Financial Reporting Standards (IFRS) 9, will have a profound impact on banks.
Banks will need to substantially increase provisions in order to provide extra cushioning against potential credit losses. Provisions are simply the cash a bank sets aside to cater for potential losses in case a borrower defaults on a loan.
The previous accounting standard, known as IAS 39, required banks to start setting aside provisions when borrowers begun exhibiting signs of distress—typically when they failed to service a loan for three consecutive months. It was a reactionary regime. In contrast, IFRS 9 will require them to set aside provisions from the get-go. It is, figuratively speaking, a “better safe than sorry” approach in contrast to the “if it ain’t broke don’t fix it” approach of its predecessor, IAS 39.
Under IFRS 9, Kenyan banks will need to manage their loan book more prudently. This is welcome news in view of the growing pile of bad loans that have strained performance in the sector in the past two years. However, IFRS 9 will also have several inadvertent consequences on the banking sector. Below are four key ones to watch out for in 2018.
Lower earnings
Loan loss provisions have a material effect on profitability as the money set aside as provisions to cushion against potential loan defaults is usually taken directly from retained earnings. This means that if a bank makes higher provisions, as will inevitability be the case under IFRS 9, it will also report a commensurate dip in profitability.
At a workshop organised by Barclays Bank Kenya in September 2017 to discuss the impact of IFRS 9, analysts noted that they expected provisions in the sector to increase by 20 to 30 per cent under the new regime. In view of this, banks are likely to experience stunted profit growth in 2018, especially in the first two quarters of the year when they will be making the necessary adjustments to comply with IFRS 9.
This outlook is not unique to Kenya. On the contrary, lower profitability occasioned by higher provisions under IFRS 9 will affect the vast majority of banks around the world. including those in developed markets like Europe.
