Insights from IFRS 9 disclosures

In May 2018, the European Central Bank published the results of the ECB Banking Supervision’s thematic review of IFRS 9 implementation preparedness conducted in 2016. This review highlighted a number of challenges faced by institutions in their progression toward the implementation of
IFRS 9, which may be similar when implementing CECL.

An entity shall disclose … by portfolio segment and major security type:

• A description of how expected loss estimates are developed
• A description of the entity’s accounting policies and methodology to estimate the allowance for credit losses, as well as a discussion of the factors that influenced management’s current estimate of expected credit losses, including:
  • Past events
  • Current conditions
  • Reasonable and supportable forecasts …

An entity shall explain the inputs, assumptions and estimation techniques used to apply the impairment requirements of IFRS 9. An entity shall disclose:

• The basis of inputs and assumptions and the estimation techniques …
• How forward-looking information has been incorporated into the determination of expected credit losses, including the use of macroeconomic information …

All international banks provided required transition disclosures in the first reporting period, covering the following areas:

• Opening loss allowance reconciliation from the previous standard to IFRS 9
• Analysis of opening loss allowance under IFRS 9 by class of financial instrument
• Changes in accounting policies

The opening balance sheet under CECL will include an allowance for loan and lease losses⁶ (ALLL) that differs from the immediate prior closing balance.

Like IFRS, CECL requires transition disclosures in the period of adoption. An explanation of how expected loss estimates are developed should be provided.

Unlike IFRS, there is no specific requirement to disclose an opening loss allowance analysis by class of asset or a reconciliation to the prior year balance. All international banks provided a reconciliation and analysis by class of instrument, thereby likely creating an expectation from financial statement users. Therefore, US banks should consider how much insight to include in the opening ALLL balance. It may be helpful to explain how that balance was derived, and to reconcile it to the previous closing ALLL balance.

11 international banks disclosed which macro-economic variables were used in their expected credit loss models in the aggregate.

5 international banks disaggregated that disclosure by retail versus wholesale portfolios.

Examples of variables disclosed included:

• Retail: GDP growth, unemployment rates, house prices, interest rates
• Wholesale: Equity index, commodity prices, commercial property, credit spreads

While IFRS 9 explicitly requires disclosure of how macroeconomic information was used in the estimate, many of the international banks disclosed which economic variables were actually used. Further, 5 of the international banks disclosed the variables used by portfolio type.

Unlike IFRS, CECL does not explicitly require disclosure of macroeconomic variables. However, those assumptions may be needed when discussing current conditions and reasonable and supportable forecasts. US banks may conclude that disclosing which macroeconomic variables are used in the expected credit loss calculations is relevant to satisfy the US GAAP requirements. Further, US banks should also consider disclosing this by portfolio type, if useful to investors.

All international banks disclosed the number of forward-looking economic scenarios used.

• 53% used 3 scenarios; the remaining used greater than 3 scenarios
• 14% disclosed the type of methodology used

Unlike IFRS, CECL permits, but does not require, the use of multiple forward-looking economic scenarios to estimate expected credit losses.

Almost half of the international banks used more than the minimum number of required scenarios (3). Therefore, US banks should consider if using multiple scenarios is a key component of their process and internal controls. Further, if US banks choose to use multiple forward-looking economic scenarios, that fact may need to be disclosed.

A minority of the international banks disclosed the type of methodology used in their forward-looking analysis. However, all international banks making the disclosure indicated that a Monte-Carlo methodology was used. 

All international banks disclosed qualitative information related to the estimation methodology used, a description of inputs to the methodology and other key decisions.

Specific items of note include:

• 6 banks disclosed that they use different methodologies in defining a significant increase in credit risk (a key decision) based on the individual portfolio and further disclosed details of the methodologies used to define this key metric for each portfolio
• 10 banks used a methodology that used PD⁷ in their assessment of the significant increase in credit risk

Like IFRS, CECL requires preparers to describe how estimates are developed and which methodologies are used to estimate expected credit losses.

While the specifics are different between the standards, the international banks’ disclosures can be related to CECL because CECL permits the following:

• Different methodologies for different portfolios in estimating expected credit losses. When different methodologies are used across various portfolios, US banks should consider disclosing those methodologies and relevant key decisions used at each portfolio level.
• A methodology that uses PD and loss given default to estimate expected credit losses. Most international banks described how PD is defined in their calculation. US banks should consider doing the same in their disclosures.