New accounting standard on loan-loss provisions to dent bank profits

„To make capital ratios difficult

Sri Lanka’s banks are expected to face a yet another challenge, this time from a new accounting standard, which came into effect on January 1, 2018.

The new International Financial Reporting Standard 9 issued on financial instruments will increase the provisions against the possible loan losses and compress margins exerting pressure on the bottom line and thereby the regulatory capital, the banks said.

Commercial Bank of Ceylon PLC (Combank), Sri Lanka’s largest private sector lender by assets, said the change in the accounting methodology in classification and measurement of the possible loan losses under the new standard, would lead to higher impairment provisions by banks.

“Adoption of the ‘expected loss model’ in place of the ‘incurred loss model’ for impairment testing upon implementation of SLFRS 9 is expected to substantially increase the impairment provision of banks,” Combank said in its annual report.

Sri Lanka fully adopted IFRSS in their original form in financial reporting and thus all international accounting standards are also identified as Sri Lanka Financial Reporting Standards, in their identical form.

The provisions against possible bad loans have tended to be more subjective estimates based on management judgments and these provisions could be used to manipulate profits to show a better financial performance across different reporting periods.

There was a case in the latest financial reports of one of the leading banks where it had reported a hefty collective impairment provision reversal although its asset book had grown.

SLFRS 9 appears to have reduced these management biases as the new standard requires the bank to recognize the 12-month expected credit loss although the loan had not exhibited a significant deterioration in the asset quality.