Link between Risk and Capital measures and IFRS 9

The International Accounting Standards Board  (IASB) has developed IFRS 9 to address the shortcomings of the incumbent IAS 39 standard by mandating a new method for applying risk metrics to accounting.
As part of IFRS 9, firms will need to analyze business model information and the cashflow characteristics of their financial assets to determine whether the assets should be measured at amortized cost or fair value. They will also need to calculate the ECL for their assets over either a 12-month or lifetime period.

This is the crucial element which will link how financial institutions use internal risk models to calculate risk measures i.e. Economic or Regulatory Capital tied together with the requirements to calculate ECL for their assets over a period of time.

Marco Folpmers in this article provides a clear link between risk measure Economic Capital and IFRS 9.

New life for Economic Capital: IFRS9


Firms face a major challenge to source and integrate the disparate data required for IFRS 9. Much of the data will come from risk and finance – two functions that have historically operated in isolation from one another, applying different standards to the data they use. Other important data, such as business model information, is unlikely to be held in a systematic manner at present. Difficult decisions will also need to be made about which macro-economic data to use and how it should be sourced.

This will also create futher incentives to integrate the risk and finance functions within financial institutions. 

Firms’ provisioning requirements are likely to be greater under IFRS 9 than IAS 39, as the new standard includes a longer list of scenarios under which the lifetime ECL must be applied.

As a result, firms will want to do all they can to mitigate their provisioning requirements, including leveraging correlations between individual entities.