This is only applicable to firms to which CRD IV applies and that apply any of the following, in relation to ICAAPs based on accounts as at 31 December 2017 or a later date:
- International Financial Reporting Standards (IFRS)
- FRS 101
- FRS 102 and have opted to use IFRS 9 for their financial instruments.
IFRS 9 was issued in July 2014 and sets out new rules for accounting for financial instruments, replacing the rules in IAS 39. Following endorsement for use in the EU, IFRS 9 is effective for annual periods beginning on or after 1 January 2018. The most significant change for banks and building societies relates to the introduction of a forward-looking expected credit loss (ECL) model.
In December 2016, the PRA recognised the early stage of implementation of IFRS 9 in firms’ accounting arrangements and said that firms should continue to submit a full set of forecasts on an IAS 39 basis and separately provide reasonable estimates of the day one impacts of adopting ECL and ECL forecasts under base and stress scenarios.
In March 2017, the Basel Committee on Banking Supervision (BCBS) released details of standards for transitional arrangements (transitionals) to phase-in the impact of ECL accounting on capital resources. The EU is expected to adopt similar arrangements in 2017. In a letter to CEOs, published on 25 September 2017, we encouraged UK firms to use any transitionals agreed internationally and in the EU as they adjust to the new regime, provided that the arrangements are broadly similar to those currently being considered. Subject to the need for sufficient resilience at the end of the transitional period, our intention is that all aspects of supervision of a firm using the transitionals would be carried out using ‘transitional’ data on capital resources and not ‘fully loaded figures’.
This clarification on transitionals does not change the way we set the PRA buffers in 2018 – see Policy Statement 17/15 'Assessing capital adequacy under Pillar 2'. These will remain subject to supervisory decision on a case-by-case basis and will reflect a range of firm specific considerations, including the quality of the data used in the ICAAP.
We intend to publish additional clarification for firms participating in Concurrent Stress Testing in due course.
For ICAAP documents based on accounts as at 31 December 2017 or a later date, we expect those firms in scope to prepare their ICAAP on an IFRS 9 basis. More specifically:
IFRS 9 starting point: Firms should use the initial date of application of IFRS 9 as a starting point for their ICAAPs rather than the closing IAS 39 balance sheet date. For example, firms with a December 2017 year-end should use 1 January 2018 as a starting point; firms with a 31 March 2018 year-end should use 1 April 2018.* This should allow firms to include Day-1 IFRS 9 impacts into forecasting starting points. Separately, firms should provide an IAS 39-comparable starting point to allow supervision to understand the Day 1 changes between the closing balance sheet under IAS 39 and the opening balance sheet under IFRS 9. Firms should separate out impacts due to ECL provisioning and other elements, for instance, classification and measurement, breaking down this information by material portfolios and sectors where possible. This only applies the first time a firm switches over to IFRS 9.
* This information may come from ‘transition documents’ prepared together with, or shortly after, the firms’ audited year-end accounts and forming part of the firms’ opening balance sheet for 2018.
IFRS 9-based forecasts: Firms are expected to submit a full set of forecasts on an IFRS 9 basis for base and stress test scenarios. For ICAAPs based on accounts as at 31 December 2017, this information can be submitted on a reasonable endeavours basis. If a firm is unable to provide this information, it should contact its supervisor.
Transitionals and supervisory approach: It is likely that the Capital Requirements Regulation (CRR) will be amended to establish transitionals for the impact of IFRS 9 ECL accounting on credit institutions’ regulatory capital resources. Based on the current draft legislative texts for amending the CRR, it appears probable that the use of these arrangements will be at the option of the individual firm.
Our position is that, subject to the need for sufficient resilience at the end of the transitional period, all aspects of supervision of a firm using the transitionals, including the firm’s stress tests, would be carried out using ‘transitional’ data on capital resources and not ‘fully loaded’ figures. In particular, since stress tests should reflect how stress would be experienced in reality, when a firm is using the transitionals such tests will fully take account of the arrangements.
Therefore, a firm using transitionals should produce base and stress-case capital ratios which incorporate the impact of IFRS 9 transitional adjustments.
Current drafts of the transitionals envisage that firms using them will be required to disclose publicly their actual (not stressed) capital ratios on a fully loaded as well as transitional basis. The European Banking Authority (EBA) is consulting on Guidelines for the appropriate disclosures, based on prior work by the BCBS, and published draft Guidelines for this disclosure on 13 July 2017.
To align with these disclosures and to allow a better understanding of the forecast modelling made by firms in their capital plans and stress tests, firms should include in their ICAAPs both fully loaded and transitional capital forecasts for their base and stress scenarios. This will allow a better understanding of the impact of fully loaded IFRS9 standards on banks’ capital ratios, albeit we set stress testing buffers based on capital ratios after the applications of transitionals.
Final remarks: Our approach will continue to recognise that firms will still be refining their IFRS 9 processes and practices during 2018 and that the quality of information will improve with time, while reinforcing the need for firms and the PRA to be prepared for the estimated impact of IFRS 9 on capital resources from 1 January 2018.
Firms unable to incorporate IFRS 9 in their ICAAP should contact their supervisors. If we are unable to assess adequately the impact of a stress on a firm’s capital position under IFRS 9 and the firm is unable to provide sufficient information, we may take action on a firm-by-firm basis as set out in paragraph 9.31 of Statement of Policy ‘The PRA’s methodologies for setting Pillar 2 Capital’.
Firms submitting their ICAAPs based on accounts as at 31 December or a later date before 31 December 2017 can refer to the Clarification issued on 6 December 2016.