Judul : The International Financial Reporting Standard (IFRS) 9 and its Implications on Islamic Financial Institutions (IFIs)
link : The International Financial Reporting Standard (IFRS) 9 and its Implications on Islamic Financial Institutions (IFIs)
The International Financial Reporting Standard (IFRS) 9 and its Implications on Islamic Financial Institutions (IFIs)
CIBAFI is pleased to present its tenth
“CIBAFI Briefing” on the impact of the
implementation of IFRS 9 on Islamic
financial institutions. This briefing
presents an overview of IFRS 9
and its new requirements regarding
impairment, classification and
measurement of financial assets and
liabilities, and hedge accounting.
This briefing will evaluate the impact
of IFRS 9 on Islamic banks through
a short survey conducted by CIBAFI,
present the key areas affected by
the implementation of the standard,
and suggest key recommendations
for a smoother adoption of future
standards
1. Introduction and Background
Accounting standards are a set of principles that
organisations follow when they prepare and publish
their financial statements, providing a standardised way
of describing the company’s financial performance and
helping investors in their decision-making process. The
International Financial Reporting Standards (IFRS), issued
by the International Accounting Standards Board (IASB), is
the most widely-used set of standards in more than 166
jurisdictions all over the world.
Several jurisdictions that
have Islamic Financial Institutions (IFIs) have adopted
these standards even though they do not meet totally the
specificities of Islamic finance transactions. The Accounting
and Auditing Organization for Islamic Financial Institutions
(AAOIFI) aims to produce standards based on IFRS while
catering to the unique characteristics of the operations of
IFIs; these are the Financial Accounting Standards (FAS).
IASB has a consultative group, established in 2011 and now
called the Islamic Finance Consultative Group, to consider
the challenges posed by applying IFRS to Islamic finance.
CIBAFI is member of this group.
IFRS 9, issued in 2014, is the IASB’s standard on financial
instruments, replacing the earlier standard IAS 39.
IFRS
9 introduces a forward-looking model for losses and
impairment expectations; a new approach for classification
and measurement of financial assets; and a new hedging
model. IFRS 9 is, in principle, mandatory for annual periods
starting from 1st January 2018 and beyond, with early
application permitted. However, some jurisdictions have
introduced IFRS 9, but with plans for a later application date.
AAOIFI has revised several of its standards in response
to IFRS 9. The most important revisions are in FAS 30,
which introduces a forward-looking model for losses and
impairment broadly similar to that of IFRS 9 (replacing the
relevant parts of FAS 11). However, FAS 251 and FAS 352 are
also relevant.
Some jurisdictions require Islamic banks in their territories to
account under IFRS. Others require them to account under
AAOIFI standards, in some cases with IFRS as a fall-back for
topics not covered by AAOIFI. Others still have their own
national standards, though these may draw heavily on either
IFRS or AAOIFI standards. Whichever approach is taken, it
is common, though not universal, for banking regulators to
give more detailed advice on the application of the relevant
standard.
2. Implications of IFRS 9 for Islamic banks
The application of IFRS 9 in several jurisdictions poses a few
challenges to Islamic banks. The new standard aims to bring
more transparency, accountability and efficiency to financial
markets across the globe through streamlined, high-quality accounting criteria. Thus, where applied, IFRS 9 presents a
challenge to Islamic banks, particularly in weak regulatory
environments, in their need to adapt their reporting to
the new requirements introduced.
This mainly affects the
following areas:
• Impairment;
• Classification and measurement of financial assets and
liabilities; and
• Hedge accounting.
2.1. Expected Credit Loss Model and the New
Model’s Implications
IFRS 9 introduces a new model of impairment for faster and
fuller recognition of expected credit losses (ECLs) based on the
historical events, current condition and forecast information.
The new impairment model requires impairment allowances
for all exposures from the time a loan is originated, based on
the deterioration of credit risk since initial recognition. The
model uses a three-stage approach to determine the ECLs: if
the credit risk has not increased significantly (Stage 1), IFRS
9 requires allowances based on 12 month expected losses;
however, if the credit risk has increased significantly (Stage
2) or if the loan is ‘credit impaired’ (Stage 3), the standard
requires allowances based on lifetime expected losses. FAS
30 introduces a broadly similar approach.
This model of impairment is expected,
in general, to result in higher credit
loss provisions for financial institutions.
It also presents several challenges to
financial institutions, including:
• Possible problems in terms of the required amendments
to systems and processes; and
• Lack of available and quality data: institutions need a
large amount of historical, current and forward-looking
data to build a model upon which judgements for
expected losses can be based.
2.2. Classification and Reporting of Financial
Assets under IFRS 9 and FAS 25
Under IFRS 9, financial assets are classified into three
categories according to the business model and contractual
characteristics of the cash flows associated with the assets:
i. assets measured at amortised cost; ii. assets valued at fair
value through other comprehensive income; and iii. assets
valued at the fair value through income statement.
The corresponding AAOIFI classification for investments is
found in FAS 25, where the terminology is: i. Investments
measured at amortised cost; ii investments measured at
fair value through equity; and iii investments measured at
fair value through income statement. In both standards,
however, banks initially identified some difficulties in
classifying some of the instruments of Islamic finance,
especially hybrid contracts.
2.3. Hedge Accounting Model Requirements
under IFRS 9
IFRS 9 improves the decision-usefulness of financial
statements by better aligning hedge accounting with the risk
management activities of an entity. If certain eligibility and
qualification requirements are met, hedge accounting allows
an entity to match gains or losses on financial hedging
instruments with losses or gains on the risk exposures they
hedge. There are some differences in hedge accounting
between IAS 39 and IFRS 9, but the hedge accounting
continues to be optional. Because of the very limited Shariahcompliant hedging instruments available, it is unlikely that
these provisions will be used much by Islamic banks.
3. Islamic Banks’ concerns and the CIBAFI
survey
There had been considerable concern about IFRS 9 on
the part of both banks and regulators in the run-up to
its implementation. In June 2018, the Islamic Financial
Services Board (IFSB) published in its annual Stability Report
a survey of regulators on the impact of IFRS 9, conducted in
mid-20173. Although only two regulators were able to offer
quantitative data on the expected impact on Islamic banks,
overall, the respondents identified several areas of high
concern to them, as well as to Islamic and conventional banks
in their jurisdictions. These concerns revolved particularly
around the availability of data and resources to compute ECL
provisions, highlighting the development of an ECL model as
a complex process and emphasising that smaller banks are
set to face more challenges in comparison to bigger banks.
CIBAFI had also various concerns from its members about
how IFRS 9 might impact on them.
CIBAFI decided that it might be
helpful to survey Islamic banks’
actual experience in the early
implementation of IFRS 9, in part
to see whether earlier concerns
had been confirmed
It therefore conducted a short survey of 13 selected Islamic
banks across a range of jurisdictions. The survey was
conducted in mid-2018.
The jurisdictions included some financial institutions which
had implemented IFRS 9, in succession to IAS 39, and some
which had implemented, or were implementing, its AAOIFI
counterparts.
One jurisdiction had, as yet, implemented
neither, and one jurisdiction with its own standards had
nevertheless required banks to use IFRS 9 from 2019. No
jurisdiction had required banks having previously used
AAOIFI standards to use IFRS 9, or vice versa, except one
which had required the use of IFRS 9 as an interim measure
while it prepared implementation guidance for FAS 30. This
implies that it considered the differences between the two
relatively small, a view reinforced by the fact that some banks in jurisdictions where AAOIFI standards are mandated
nevertheless reported themselves as implementing IFRS 9.
Because of the relatively small number of banks surveyed,
the sample cannot be seen as statistically representative.
In addition, while some banks were well into the process
of implementing IFRS 9 or its AAOIFI counterparts, others
had not yet begun. They are therefore responding from
different situations. For these reasons, the results are in
general presented in narrative rather than statistical form,
but they are nevertheless highly informative.
4. Survey results
The survey aimed to evaluate the impact of IFRS 9 on Islamic
banks. In general, banks were asked about the challenges
faced in IFRS 9 implementation; the effect of IFRS 9 and
the new impairment model on Islamic banks’ balance
sheets, capital adequacies, collateralization, and products
& services; as well as on any Shariah issues faced in the
implementation of IFRS 9.
The survey comprised both “closed” and “open-ended”
questions. The open-ended questions were intended to
enable industry leaders to express their views in the most
effective and detailed way, while the closed questions
aimed to evaluate the influence of IFRS 9 on Islamic banks
regarding certain aspects. For the latter, a scale from 1 to 5
was usually used, where 1 refers to no impact/effect, while
5 refers to high impact/effect.
4.1. Balance Sheet Impacts
When the banks surveyed were asked which aspect of
balance sheet accounting they thought would be most
affected from the implementation of IFRS 9, impairment
clearly came top of the list with an average score of 4.15,
showing that the majority of the banks are expecting the top
level of impact. A moderate level of impact was expected in
the area of classification and measurement, with an average
score of 3; however, most banks expected no impact at all
on hedging, with some of them expressly citing the lack of
Shariah-compliant hedging instruments. This is broadly in
accordance with prior expectations.
4.2. Impairment Methodology
A further question asked specifically about the scale of
the impact from the changes in impairment accounting,
measured by the increase in provisions between 2017 and
2018. Of the banks that had made estimates, 5 expected
either a decrease or an increase of less than 5%, one
expected an increase of 5-10%, one 10-20%, one 20-30%
and three expected more than 30%. One of these, however,
was in a jurisdiction where IFRS 9 is not yet required.
We also asked about the extent to which the new impairment
methodology would impact the bank’s capital adequacy,
product pricing or collateralization. In general, Islamic
banks expected a low to moderate impact on each of these,
with two outliers expecting the highest level of impact in
each area. One of these also expected a high level of impact
on profitability, taxation policy and dividend policy – but,
interestingly, this bank is in a jurisdiction that has not yet
mandated IFRS 9 (or its AAOIFI counterpart)
When asked what data the banks would use to build their
new impairment model, all but one expected to use historical
data; however, eight of these twelve had data for less than
five years, and none of them had data for more than ten
years. Banks also expected to use external and forwardlooking data, mainly relevant macroeconomic information
and analysis. Only half expected to use the bank’s own
forward view of future economic conditions. These
responses suggest that some banks will struggle with both
data availability and the necessary analytical capability.
4.3. Islamic Contracts and Shariah Issues
We asked specifically about the impact of IFRS 9 on the
particular Islamic financial products and services. In
general, Islamic banks expected slight impact on investment
accounts, partnership-based contracts such as Musharakah
and Mudarabah, Sukuk and moderate impact on off-balance
sheet accounts. The picture was more mixed between
moderate to significant impact for lease-based contracts such
as Ijarah, and for sales-based contracts such as Murabahah
and Salam. Two banks, however, expected the highest level
of impact in essentially every category, with a third only just
behind them. Of these three, one is in a jurisdiction that has
not yet mandated IFRS 9; and one is in a jurisdiction where
the Central Bank has a record of specifying the calculation of
provisions in a way very different from IFRS 9, and was still
issuing new guidance at roughly the time of the survey. This
indicates that the issues here may be jurisdiction-specific.
We also asked about any Shariah issues raised by IFRS
9. Some of the banks were in fact applying the AAOIFI
counterparts, so unsurprisingly found no Shariah issues.
In other cases, survey comments revealed that banks
were using AAOIFI standards, or guidance from their own
regulators, to resolve any possible ambiguities, even when
applying IFRS 9.
In fact, no Islamic bank
identified any Shariah issues in
the implementation of IFRS 9.
4.4.Challenges and Influences in Implementation
We asked Islamic banks to rank the challenges involved in
implementing IFRS 9 in their own situation from 1 (least
important) to 6 (most important). There was a wide spread
of responses, but the clear leader overall was the availability
and quality of data with a score of 5.08, followed by limited
internal resources, co-ordination between departments, and
ability to implement along with other initiatives. All of these
were more important than clarity of IFRS 9’s interpretation
or the relationship between IFRS and AAOIFI standards.
When we asked which bodies would be most important in
providing interpretation for the implementation of IFRS 9
in the jurisdiction, the regulatory and supervisory authority
clearly stood out ahead of standard-setters, auditors and
external consultants, with the bank’s peer group in last
place. This is supported by some of the write-in comments,
which emphasize strongly the role of the central bank or
other regulator
5. Conclusion and Recommendations
Overall, the pattern that seems to be emerging from this
limited survey is that, although the implementation of IFRS
9 and its AAOIFI counterparts has proved challenging for
many Islamic banks, some of the worst fears have not
been realised. For most banks, the impacts on key balance
sheet figures, though material, seem to be at levels that
would be manageable. The responses in this area are,
however, quite variable, and sometimes differ significantly
even between banks in the same jurisdiction. This suggests
that idiosyncratic factors are at work, and regulatory and
supervisory authorities will need to be alert for any banks
that are hit particularly hard.
With regards to the interpretation of the standard, banks
appear very reliant on guidance from their regulators,
in contrast with the situation in many Western countries
where banks rely more on their own resources or those of
accountancy advisers.
As a result, where the regulatory
or supervisory authority gives clear guidance, banks are
content to follow it and therefore have few difficulties of
interpretation. The jurisdictions where interpretation has
been a problem for some banks seem to be largely ones
where guidance had not been forthcoming at the time of
the survey, or where their relationship to other regulatory
guidance still needed to be resolved. Regulatory and
supervisory authorities therefore need to continue to
support their industries with guidance, and to engage with
them to understand where they are meeting difficulties.
Conversely, financial institutions, especially those where
IFRS 9 is still to be fully implemented, must be proactive
in their interpretation and implementation and not wait
for regulators to issue further guidance. For that purpose,
they may need to use consultants, experts or audit and
accounting firms.
Islamic banks identified no Shariah-related issues with IFRS
9. In some cases, this was because they were in fact using its
AAOIFI counterparts; in others, because they relied on their
regulatory or supervisory authority to have resolved these
when giving guidance. In at least one case, it appeared that
the bank was actually using AAOIFI standards to guide its
interpretation of IFRS 9.
Implementation of IFRS 9 is nevertheless proving
organisationally challenging. The challenges appear to be
mainly concerned with the new impairment rules, and the
need to build expected credit loss models. Banks, which
may have been used to following mechanical rules in this
area, are finding that the building of models is technically
challenging and requires cross-organisational working which
may itself be difficult. In addition, they often do not have
the long data series needed as inputs to these models, and
the internal economic skills to create or use forward-looking
information. While there is little that can be done to supportthose banks that are already implementing IFRS 9, those
banks for whom this is still in the future should ensure that
there are adequate resources to support it, especially in the
areas of modelling and economic analysis, and that they are
already creating the data series that will be necessary to
feed the models.
In addition, the issues that Islamic banks have encountered
and are still facing in implementing IFRS 9 may be taken into
consideration for the revision of upcoming standards such
as IFRS 17 on ‘Insurance Contracts’. IFRS 17, issued in May
2017, replaces IFRS 4 to provide additional and amended
requirements for consistent accounting principles for
insurance contracts and will be effective for annual periods
starting from 1st January 2021. As insurance companies
are preparing themselves for the new accounting standard,
Takaful companies are facing significant uncertainty in how
to interpret and apply the new standard to their business.
IFRS 17 was developed largely based on conventional
insurance structures, which makes its implementation by
Takaful companies not very straightforward. Thus, before
its implementation in 2022, the Islamic financial industry
practitioners, actors and Regulatory and Supervisory
Authorities (RSAs) are encouraged to do further research,
open debates and highlight issues that may be challenging
for Takaful companies in applying IFRS 17. This will help
to mitigate future problems, such as defining the data that
should be collected in order to report under IFRS 17, and
integrating any IFIs’ specificities within the standard for a
comprehensive global accounting framework for insurance
contracts. Furthermore, AAOIFI should plan to complete any
changes to its own insurance standards by no later than
mid-2020, so that they can be implemented in parallel with
IFRS 17 and with reasonable time for preparation
The end of article The International Financial Reporting Standard (IFRS) 9 and its Implications on Islamic Financial Institutions (IFIs)
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