Capital adequacy in the transition
(Extract from page 47 of BIS Quarterly Review, March 2017)
While supporting ECL provisioning standards, the BCBS is considering the implications for regulatory capital.
One concern is that the impact of ECL provisioning could be significantly more material than currently expected and result in an unexpected decline in capital ratios. The two-year difference between the IASB and FASB implementation dates could also raise level-playing-field issues.
With these concerns in mind, in October 2016, the BCBS released a consultative document that proposed to retain for an interim period the current regulatory expected loss (EL) treatment of provisions under the standardised and the internal ratings-based (IRB) capital approaches for credit risk. In addition, the BCBS requested comments on three possible transition approaches to allow banks time to adjust to the new ECL accounting standards.
- Approach 1: Day 1 impact on Common Equity Tier 1 (CET1) capital spread over a specified number of years;
- Approach 2: CET1 capital adjustment linked to Day 1 proportionate increase in provisions; or
- Approach 3: Phased prudential recognition of IFRS 9 Stage 1 and 2 provisions.
The BCBS mentioned that its current preference is for Approach 1 because it directly addresses a possible "capital shock" in a straightforward manner. Nevertheless, comments on Approaches 2 and 3 were encouraged because they consider the ongoing evolution of ECL provisions during the transition period and not just the impact at the date of adoption of ECL accounting on banks' provisions and CET1 capital. Once finalised, any transition approach would be accompanied by related Pillar 3 disclosure requirements.
BCBS (2016c, 2016d). As previously mentioned, IFRS 9 will be effective in 2018 and the FASB's CECL standard will be effective starting in 2020 for listed companies and 2021 for all other firms.