- But says banks need to do proper estimate on impact on profits and capital
- Says can allow staggered application of capital requirements under BASEL III
- Impact on impairment provisions of some banks from IFRS 9 are estimated as high as 40%
The Central Bank this week said they could be lenient on higher capital ratios under the new BASEL III rules but the banks need to convey by how much their profits and capital bases may get eroded from the new accounting standard on loan loss provisions.
Sri Lanka fully adopted the IFRS 9 or the new International Financial Reporting Standard on financial instruments on January 1, 2018, replacing its earlier version of IAS 39 and the application of the standard is estimated to substantially increase the impairment provisions on the loans with a knock-on impact on profits and capital. As a result, some of the banks might find it challenging to meet the elevated capital ratios under the BASEL III, which is slated to come into full effect on January 1, 2019.
Hence, to avoid any likely breach of these minimum capital levels by banks, the Central Bank has asked the banks to provide them with a reliable estimate of the impact on their capital augmentation plans.
“Even in this IFRS 9 process, we have told the banks to provide us with the impacts and we will definitely facilitate with regard to the difficult positions that they are going to face in looking at the capital situation”, Central Bank Assistant Governor Yvette Fernando said.
Speaking at a public – private policy dialogue organized by the Ceylon Chamber of Commerce on Monday to discuss the regulatory and compliance challenges facing the banking sector, she said if credible estimates can be given, the Central Bank can allow staggered application of the capital requirements, which is also allowed by the BASEL III accord.
“So, the only issue is that we have still not got a proper estimate. There are some vague figures but it will take a little more time for us to get the numbers. Once the numbers are available and if we are confident that they are the proper numbers, definitely the Central Bank will give some staggered application of the capital requirements because BASEL has provided that discretion to the national regulator so that, that kind of facilitation can be provided”, added Fernando, who was also a former Director, Bank Supervision, at the Central Bank.
The announcement may prompt many small and mid-sized lenders who find it challenging to meet the higher capital requirements to take up the matter with the Central Bank collectively.
Meanwhile, the Managing Partner at KPMG Sri Lanka, Reyaz Mihular who delivered the keynote address at the event said the impact on impairment provisions of some banks from IFRS 9 are as high as 40 percent.
“I know that the impairment on ECL, the impacts on banks are sometimes around 40 percent in some of the cases. Not unusual”, he said, adding that in certain other jurisdictions, the impact is higher.
Unlike the ‘incurred loss model’ under the previous IAS 39, where a bank awaits a facility demonstrating signs of sourness before making a provision, the IFRS 9 assumes a probable loss on the very first day the loan is granted resulting in a provision during the first year of the facility.
Further, when the facility indicates a serious deterioration in the quality, the new standard requires the bank to make provision for the life time of the facility.
The new provisioning method under IFRS 9, which is called the ‘Expected Loss Model’, though inherently judgmental, Mihular said the new standard is very much aligned with the business model of the bank, while it takes out the ability to postpone provisions or making inadequate provisions on possible bad loans.
“When IFRS 9 comes in, the impairment provisions are going to get escalated. So, what will happen is about 30 to 40 percent of impairment losses are going to come and hit you. It might get through your reserves.
When it hits your reserves, what will happen is your pool (capital) what is needed for BASEL III is going to be eroded. So, your capital adequacy is going to get affected through that”, Commercial Bank Chief Financial Officer Nandika Buddhiplala said.
Pix by Kushan Pathiraja