Banks to adopt more impairment costs

All banks and finance companies will adopt more impairment costs on their loans in line with new accounting standard, SLFRS 09.

This standard, issued in July 2014 is effective for annual periods beginning on or after January 1 2018, with early adoption permitted. It replaces LKAS 39 Financial Instruments: Recognition and Measurement which recognises impairments on incurred loss method. SLFRS 09 deals with the measurement and recognition of expected credit losses on the balance sheet of a company. It is intended to reflect the pattern of credit deterioration or improvement over the life of - say a loan for an example. The new standard will impact the financial institutions’ – especially banks’ profitability, but it’s a more sustainable model.

Now banks can forecast about two to three quarters ahead as to which loans may go bad for an example and allocate provisioning for them, unlike earlier when they waited for a considerable time to do so. This is an expected credit loss method meaning for an instance they can analyse the consumer sector and if it’s weak then forecast credit losses. Already many banks, having assessed the impact on transition based on gap analysis and quantifications on their financial statements, said that they aim to allocate 30 per cent to 50 per cent allocation to adopt SLFRS 9.

Financial statements depict the story of the actions of the business, an analyst explained. “So now a bank will assess its loans critically. Say it recognises that a certain construction firm won’t be able to pay a loan, and then it will identify similar construction firms that have loans from that particular bank. Then the bank will bundle all this together, and forecast what percentage will ‘ go bad’ and make an adjustment in its balance sheet,” he explained further.

This is a more prudent way for provisioning and more forward looking at the same time. However now it’s more subjective than earlier. Which may be why the financial institutions need to have a more robust sector as well as financial forecasting, banking sector experts say. Many banks have already said that they will be adopting the new standard and also give a total estimated percentage.

Seylan Bank has said in its 3Q2018 results that based on the preliminary assessments undertaken, the estimated additional impairment provision on the financial statements for the year ended December 31, 2017, on adoption of SLFRS 9 is expected to be in the range of 30 per cent to 45 per cent of the total impairment provision on different portfolios. “The total impairment costs of the bank increased by 33.57 per cent from Rs. 1, 440 million to Rs. 1,923 million. Further, SLFRS 09, issued in July 2014, is effective for annual periods beginning on or after 1 January 2018, with early adoption permitted.”

NDB has estimated the additional provision on the financial statements on adoption of SLFRS 9 to be approximately 40 per cent-50 per cent higher of the total impairment provision due to the new standard. “Thus additional provisioning for 2017 could range between Rs. 2 to Rs. 2.4 billion while impact on the current year could range between Rs. 1.1 to Rs. 1.5 billion for 9M’18.”

Commercial Bank has performed a provisional calculation for SLFRS 9 and has estimated the total additional loan loss provision as at 31 December of last year on adoption of SLFRS 9 to be in the range of 25 per cent to 35 per cent. “The bank also noted that the total estimated additional loan loss provision as at December 31, 2017 on adoption of SLFRS 9 is expected to be in the range of 30 per cent to 35 per cent compared to the total impairment provision determined as per LKAS 39. Accordingly, the increase in impairment provision based on SLFRS 9, had it been effective as at December 31, 2017, would have reduced the Group’s/ Bank’s net assets by approximately 4.5 per cent to 5.5 per cent and the total Capital Adequacy Ratio by 60 to 75 basis points.”

Hatton National Bank has performed a provisional calculation for SLFRS 9 and has estimated the overall cumulative impairment provision to increase by Rs. 5.5 - 6.5 billion, the profits to have dipped by Rs. 600 million – Rs. 800 million while total capital adequacy ratio to have decreased by 60-70 bps had SLFRS 9 been applied for the nine months in ’18.

Sampath has also disclosed the application of SLFRS 9 and it is expected approximately 32 per cent increase in overall impairment provision as at 30th September 2018 ( 31st December: 34 per cent). The increase in impairment provision under SLFRS 09, had it been effective as at 30th September 2018, would have reduced the bank’s net assets by approximately 3.7 per cent ( 31st December 2017 - 3.3 per cent) and the Total Capital Adequacy ratio by approximately 50 basis points as at 30th September 2018, Sampath said.

Now banks can forecast about two to three quarters ahead as to which loans may go bad for an example and allocate provisioning for them, unlike earlier when they waited for a considerable time to do so