Changes under both IFRS and US GAAP are resulting in significant changes to quantitative and qualitative models that banks, insurance companies, and other financial institutions use for measuring financial instruments, including loans, leases, and debt securities. Institutions need to update and / or adopt new procedures, controls and processes for determining Other Than Temporary Impairment (OTTI) and Allowance for Loan and Lease Losses (ALLL).
While the FASB and IASB both sought to develop a forward-looking expected credit loss model that would provide more timely loss recognition than the incurred loss model, they ultimately diverged on specific requirements.
The FASB’s new model requires companies to estimate lifetime current expected credit losses (CECL) for all in-scope financial instruments (ASC Subtopic 326-20 Accounting for Financial Instruments – Credit Losses).
The IASB’s model, issued as an amendment to IFRS 9, Financial Instruments, requires recognition of lifetime credit losses only for financial instruments in which there has been significant credit deterioration. For all other financial instruments, IFRS 9 requires companies to estimate losses that are expected to occur within the 12 months following the reporting date.
IFRS 9 amendments are changing how financial assets are classified and measured. While assets are still classified individually as held-to-maturity, available for sale, trading or loan / receivable, the basis is changing. Formerly, assets were classified largely on a company’s intent. Going forward, asset classes will be based on cash-flow characteristics and the business model under which assets are managed.
Debt instruments will be recorded at amortized cost only if contractual cash flows consist solely of payments of principal and interest (SPPI) and the business model’s objective is to hold the asset to collect contractual assets.
The FASB’s amended ASC 825, Financial Instruments, will require most equity securities to be recorded at fair value through profit & loss, including many equity securities that currently qualify for the use of the cost method.
IFRS 9 replaces the existing hedge accounting model with one more closely aligned with a company’s risk management objectives. Quantitative effectiveness thresholds will be eliminated and replaced with qualitative criteria that are more flexible and will allow companies to designate additional risks as hedged items, including risk components of non-financial items and net positions.
In contrast to the sweeping IFRS 9 changes, FASB's ASU 2017-12 largely retains the existing hedge accounting model, offering targeted improvements, particularly in terms of additional exposures that may be designated as hedge items. Under the new guidance, risk components of nonfinancial items can be designated as hedged items if they are contractually specified. It also allows a “last of layer” approach for fair value hedges.
While the new IFRS 17 reporting standard for insurance contracts won't take effect until 2021, meeting this deadline will be a major challenge for many insurers. Compliance will require new or upgraded systems and controls, as well as unprecedented coordination between finance, actuarial and IT functions.