How new global financial reporting standard will affect local banking industry

Local banks will soon adopt the new international financial reporting standard (IFRS 9), a move that is aimed at improving the accounting and reporting of financial assets and liabilities, enabling banks to reduce non-performing loans. This mandatory standard came into force on January 1 globally. Rwanda is yet to implement the new model that has already raised a lot of questions among sector players. IFRS 9 replaces the International Accounting Standard 39, which had been criticised for being “complex and inconsistent with the way entities managed their businesses and risks,” sector experts said while discussing the financial instrument last week. They say the new standard may impact the country’s financial system and efforts towards becoming a financial hub by 2020. With the new standard, entities will have to start providing for possible future credit losses in the very first reporting period a loan goes on the books – even if it is highly likely that the asset will be fully recovered. Under the new standard, banks will have to align measurement of financial assets with their business models, as well as contractual cash flow of instruments and future economic scenarios, according to Stephen Ineget, the KPMG Rwanda partner. Addressing top executives of financial institutions last week in Kigali, Ineget added that the new standard will “substantially” influence bank financial statements, especially how losses will be calculated. He explained that IFRS 9 financial instruments will require banks to evaluate how economic and credit changes will affect their business models, portfolios, capital flow and the provision of loans. “It means, therefore, that both the regulator and banks must now consider the wider impact of implementing this new standard on the overall performance of the sector, including earnings and the balance sheet in regard to profitability and capital adequacy requirements,” he told Business Times.Impact on sector, businesses The biggest worry among financial sector players is that the new standard could result into increased interest rates, if not handled properly. Experts say IFRS 9 financial instruments raise the risk that more assets will have to be measured at fair value, with changes in fair value to be recognised (as they arise) in profit and loss statements. In addition, entities will have to start providing for possible future losses in the very first reporting period of embracing the standard. For instance, a bank should start providing for possible future losses if it gives out a loan “even if it is highly likely that it will be fully recovered”. However, if not managed well, the new approach could push up cost of finance, according to GTBank managing director Veracruz Olabayo. “The new measures may make it hard for banks to grow their loan books, leading into significant reductions in capital adequacy levels. In the worst case scenario, it will make it hard to attract more equity, resulting into increased interest rates,” he said. Already, the business community has been complaining of high interest rates, which they say are hurting competitiveness and profits. BPR board chairman Njuguna Ndungu (left) is joined by clients to cut a cake at an event last year. Local financial institutions say the new international reporting standard may lead to an increase in interest rates. / File How the new approach may lead to increase in loan rates Banks may be required by the central bank to put aside a certain amount of as provision to cover loans that are deemed as risky and with high default rate. If the default rate is high or borrowers are not paying on time, this is where the problem could arise necessitating a sort of deposit by banks to cover those loans. KPMG’s Ineget said: “The whole idea is that banks will have to make these provisions on loans. This means that, if banks are not sure the customer will pay back, they will actually want to include that risk by adding the in cost loans. This may result into increasing interest rates.” He, however, noted that if banks put in place strong systems to assess and monitor borrowers, then this will not be necessary. “Therefore, it is important for banks to first put in place these systems before implementing the new standard,” he said, adding that discussions are still ongoing on how best to roll out the new model. Banks raise concern However, the main concern will be the question of subjectivity as opposed to the general economic performance of the country, according to Dr Diane Karusisi, the Bank of Kigali chief executive. The other issue is how banks will be able to harmonise their various models in order to achieve a desired outcome, she said. Karusisi pointed out that banks will need to bring onboard the credit reference bureau “to help us out on this”. The BK chief executive added that market players should continue discussions on the new standard, saying this would ensure effective implementation. Equity Bank Rwanda chief executive, Hannington Namara, said there is need for clear understanding on how the new standard will affect sectors like agriculture and mining, before it is implemented. “In addition, we need to understand how it will affect financial institutions that have a regional presence,” he said. Central bank speaks out Peace Uwase, the central bank director general in charge of financial stability, said the regulator is committed to ensuring that the sector and market generally remains stable despite the new standard. This is an area that is still developing that requires much scrutiny before implementation; we, however, already asked banks to send us their new pricing models by end of March so that we can make an informed decision as the regulator,” she said. Uwase added that central bank will work toward achieving the “best outcome” as far as the new standard is concerned. She advised banks to upgrade their systems and strengthen data collection and management to be able to benefit from the new standard. “Presently, our major concern is on a standard will which affect capital flow and profitability of the sector,” she said. “Our responsibility is to examine all the models and ensure they protect interests of all stakeholders,” said Uwase. She noted that the idea is to allow the banks to first “smoothen out” the impact the new reporting standard may have on the general performance of the sector. According to Richard Tusabe, the Rwanda Revenue Authority (RRA) Commissioner General, the new standard is a good initiative, which financial institutions and stakeholders should use as an opportunity to design a competitive tax regime that will help attract more investors into the economy. Much as the new model will inform our decision, we shall adopt whatever the central bank deems right, he said. Tusabe, however, cautioned banks to put customer interests at the forefront in whatever actions they take. “As tax authority, we are interested in seeing banks facilitating more businesses to grow and thrive… If interest rates are likely to go up, then that becomes a major concern,” he added. Tusabe also urged stakeholders to build capacity of staff and work together to ensure smooth implementation of the new standard. He said the move would create a more competitive tax regime that would help attract more boost investors into the country. More about IFRS 9 standard The standard specifies how an entity should classify and measure financial assets, financial liabilities, and some contracts to buy or sell non-financial items. IFRS 9 requires an entity to recognise a financial asset or a financial liability in its statement of financial position when it becomes party to the contractual provisions of the instrument.

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How new global financial reporting standard will affect local banking industry