Banks face lower profits on new CBN disclosure rule

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A new accounting rule mandating banks to make further disclosures of their assets, including loan portfolio, will make Nigerian lenders to report lower profits, it has been learnt.As the banks begin to roll out their first quarter financial reports this week, decline in profits is expected following the introduction of the new accounting regime by the Central Bank of Nigeria.

The new regime, called the International Financial Reporting Standards 9, among several requirements, mandates banks to make further disclosures on the state of their loan portfolios.

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Apart from coming with a new regime in the manner assets are classified in banks’ books, the IFRS 9 specifically directs lenders to make provisions in advance for non-performing loans.

This is a total departure and complete migration from making provision for incurred bad loans to expected bad loans.

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This new regime, according to financial, accounting and banking experts, will lead to a significant decline in the profits of the banks.

Provision for bad loans is usually charged directly against a bank’s profit.

The CBN introduced the IFRS 9 on January 1, 2018, and for the first time in the history of Nigerian banks, the lenders will be using the new accounting standard to report their first quarter financial results this month.

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According to industry experts, the banks will record decline in profits because the new reporting regime will make it nearly impossible for them to hide toxic assets, bad loans or expected credit losses in their books.

“It is in the 2018 financial reports that we will see the full effect of this (new rule). We should expect volatility in the amount of impairment (provision for bad loans) figures that will be reported by banks, simply because it is not just based on historical or current information, but it is based on forecast of the future that nobody knows with certainty,” the Partner, Financial Reporting Group, West Africa, Financial Accounting Advisory Services, Ernst & Young, Mr. Jamiu Olakisan, says.

Olakisan notes that the new accounting regime also considers macroeconomic indicators such as unemployment, inflation, Gross Domestic Product, and oil price to consider the probability of an expected loan loss.

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The Principal Partner, ROAC Chartered Accountants, Mr. Gbenga Akinyemi, states that while banks with robust capital base may not feel the impact so much, small and mid-size lenders may have their capital base affected negatively.

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This, he says, may affect the ability of some banks to meet up with their credit obligations to some foreign entities.

Nigerian banks are currently battling with high non-performing loans, especially small and mid-size lenders.

Akinyemi says, “The adoption of this new standard is expected to impact many items on any bank’s balance sheet irrespective of size.

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“It is expected that provisioning will increase generally, more so, for performing loans that have deteriorated in credit quality. Increase in provision will affect capital and could potentially impact covenants in external financing agreements.”

According to the ROAC expert, the IFRS 9 Financial Instruments seek to replace the previously used IAS 39 Financial Instruments in the recognition and measurement of financial instruments.

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Akinyemi explains that the IFRS 9 introduces a fundamental shift in how loan losses are treated, with them being recognised earlier than under the previous approach.

He notes, “Banks will be required to incorporate forward-looking assessments in their estimates of credit losses using the Expected Credit Loss models rather than Incurred Loss models. There is also a new classification approach for financial instruments as well as changes to hedge accounting.

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“The nature of this standard also means that the accounting processes and systems of banks are subject to drastic changes or complete overhaul, as it introduces a futuristic approach to financial instruments’ measurement.

“In addition to the requirement for improved analysis of the quality of borrowers, the new approach involves macro-economic factors, which require a lot of subjectivity. These changes will require banks to develop capacity and attract new skills to the industry.”

The Director, Banking Supervision, Nigeria Deposit Insurance Corporation, Mr. Adedapo Adeleke, says the introduction of the IFRS 9 reporting regime will worsen the bad NPL situation of the country’s banks.

Adeleke, speaking on the topic, ‘Curtailing non-performing loans in banks’, at a seminar, lists measures to mitigate the NPLs in the banking sector.

A CBN stress test has shown that only large banks will stay above the regulator’s capital adequacy ratio threshold if the non-performing loans levels of the Deposit Money Banks should rise by 50 per cent.

This was contained in the CBN’s Financial Stability Report released recently.

According to the report, the end-June 2017 banking industry stress test, which covered 20 commercial and four merchant banks, was conducted to evaluate the resilience of the banks to credit, liquidity, interest rate and contagion risks.

The banking industry was categorised into large banks (those with assets up to N1tn or above); medium banks (those with assets more than N500bn but less than N1tn); and small banks (those with assets up to N500bn or below).

The stress test results state, “The stress test showed that only large banks could withstand a further deterioration of their NPLs by up to 50 per cent. However, none of the groups withstood the impact of the most severe shock of a 200 per cent increase in the NPLs as their post-shock CARs fell below the 10 per cent minimum prudential requirement.

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“As a result of the impact of the severe shocks on the banking industry, large, medium and small banks will result in significant solvency shortfall of 15.21, 9.78, 93.42 and 17.53 percentage points from the regulatory minimum of 10 per cent CAR, amounting to N2.77tn, N1.54tn, N0.98tn and N0.25tn, respectively.”

The CBN says  the decline in the CARs is attributable to the challenges in the oil and gas sector, coupled with the slow recovery in the domestic economy, resulting to a rise in the NPLs and capital deterioration.

Olakisan, however, outlines some challenges that may face the efficient implementation of the IFRS 9 in Nigeria

These, according to him, are lack of sufficient professionals with the required skills; knowledge gap on the part of the regulators; timing of the commencement of IFRS 9 projects by Nigerian entities; and insufficient internal historical data required to support model building.

Others are lack of desired relationship between macroeconomic variables and losses; absence of sufficient forward looking macroeconomic variables to support modelling; the use of standardised approach by Nigerian banks for regulatory risk management purposes; and insufficient external rating data and coverage issue.

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