The dynamics and competiveness of the SA financial services sector are set to increase in complexity
At the start of 2011, the dynamics and competiveness of the South African financial services sector are set to increase in complexity with concerns about European debt, uncertainty about the future of the value of the Rand and with new developments in regulation and International Financial Reporting Standards (IFRS).
In response to these and other regulatory changes, PwC’s newly launched Financial Services Journal for Southern Africa 2011 (FS Journal) addresses strategic, operational and technical issues that could potentially impact the sector’s future performance. “PwC’s FS journal also covers the new expected loss impairment methodology, new developments in Service organisations, King III and Governance, The Protection of Personal Information (PoPI) and the impact of IFRS 4 Insurance Contract exposure draft on Medical Schemes” comments Tom Winterboer, PwC’s Financial Services Leader for Southern Africa and Africa.
Credit risk was rated the number two financial risk facing the global banking industry and number one in developing economies such as South Africa, according to the 2010 Banana Skins Survey sponsored by PwC. It is unlikely that much has changed given the current economic climate.
Globally, the indebted economies of Portugal, Ireland, Greece, Spain (PIGS) are placing pressure on the euro. Although Greece and Ireland have been rescued, the question many are asking is which economy will next require assistance. Globally, banks are having to assess the impact of such conditions on their impairment models.
In South Africa, the recent reductions in interest rates during 2010 meant that loan impairments have been on a decreasing trend in the last six months. Although corporate client balance sheets have appeared robust in recent times, the commercial real estate and construction sectors are still under strain.
In the retail sector, the reductions in interest rates experienced in 2010, have supported some improvements in the impairment numbers. The level of inflows of accounts into the arrears categories have reduced which in turn have reduced the impairment requirements. In the non-performing loan category, the number of clients entering the non-performing debt counselling categories has also started to stabilise and there is an increasing trend in the level of terminations (the action of removing clients from the debt counselling status and continuing with the normal legal course of action).
It is significant that the impairment provisions raised under the current IAS 39 accounting standards could be different in the years to come as the International Accounting Standards Board (IASB) develops its new expected loss impairment methodology for accounting for impairment for amortised cost loans. The global financial crisis highlighted the need to review the impairment accounting framework for financial assets and IAS 39 has come under fire for only holding impairments against incurred losses and not those that are expected. In response to the criticism, the IASB issued an exposure draft (ED) in November 2009,” says Tom Winterboer. This ED included an expected loss methodology on accounting for impairment of financial assets carried at amortised cost. This ED aimed to negate some of the shortcomings of the current incurred loss model by eliminating the need for trigger events to occur before the recognition of a credit event and subsequent recognition of impairment.
Respondents to the ED issued in November 2009 highlighted a number of operational concerns and the IASB set up an expert advisory panel (EAP) to explore how operational challenges of the expected cash flow approach as proposed in the ED might be resolved. It is evident from recent IASB updates that many suggestions made by the EAP have been considered and changes to the initial ED will be made as a result.
Initial indications are that the new IFRS statement will be released by the end of January 2011 with adoption in 2013. The IASB expects to permit early application of the IFRS.
Although we will need to wait for the ED to be published later this month, it is worth highlighting the following possible amendments to the original ED:
- The Board tentatively decided to permit the use of a 'decoupled' effective interest rate (i.e. the expected loss estimate and effective interest rate are calculated and accounted for separately over the life of the portfolio) rather than the integrated EIR approach envisaged in the original ED.
- At a joint Financial Accounting Standards Board (FASB) and IASB meeting held in December 2010, the joint boards considered the following three methods for accounting for credit impairment:
- immediate recognition of losses expected to occur over a period shorter than the expected life of the loan (for example, a reliable period in the future).
- recognition of lifetime expected credit losses using a time proportionate approach for a good book and full recognition of lifetime expected losses for a bad book. (A variation of this approach was also discussed, which would establish a floor for the good book allowance).
- a third method, whish is the same as the second method but with a mechanism to accelerate recognition of expected losses in a good book to accommodate 'front loaded' expected loss recognition patterns.
- The IASB indicated that short-term trade receivables should be excluded from the scope of the impairment ED and should instead be considered when the measurement of revenue (which is also the initial measurement of a trade receivable) is decided as part of its project on revenue recognition.
In whatever form it takes, the new expected loss methodology will mean that banks will need to update their data collection and assumption settings fairly soon. Banks should start identifying available and reliable data sources that could be used to forecast expected losses and the new approach will no doubt require changes to system requirements. Throughout the organisation, from executive level to modelling teams, training requirements will need to be considered. It will be essential that organisations upskill their people to have sufficient insight into these new accounting requirements.
In conclusion, it is generally accepted in the market that the incurred loss model has reached its expiry date and that, going forward, the expected loss impairment methodology will change the impairment landscape. Given that the expected loss impairment approach is imminent, the sooner entities consider systems, data, resource and other requirements the more prepared they will be to consider the numerous challenges the new impairment standard will offer.
Winterboer is confident that the PwC FS Journal is thought provoking in helping the financial sector navigate the intricate jigsaw of challenges and opportunities introduced by the new accounting standards and regulations.
“While South Africa has performed well in the wake of the global economic crisis, adapting to the new challenges and opportunities is key to maintaining continued success. The FS Journal provides in-depth information on some of the most significant accounting and regulatory changes and the impact on the industry.” says Winterboer.
This article was originally posted on South Africa Business Communities
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