Moody's publishes FAQ on the impact of IFRS 9 accounting standards on European banks

The early disclosures by large European banks on the impact of the new IFRS 9 accounting framework show that impact on capital levels has been limited thus far, says Moody's Investors Service in a report published today. However, the quality of banks' disclosure at this stage is uneven.

The report, "FAQ: Limited impact from IFRS 9 first time adoption, but disclosure uneven so far," is now available on www.moodys.com. Moody's subscribers can access this report via the link at the end of this press release. The research is an update to the markets and does not constitute a rating action.

Last year, Moody's estimated that under the new IFRS 9 accounting framework, the ratio of tangible common equity to risk-weighted assets (TCE / RWAs) for many European banks would fall by around 50 to 60 basis points, in line with the results of a survey of banks that the rating agency carried out in March 2017.

Disclosures have been uneven in quality, but based on those to date, the capital impact will likely be close to Moody's expectations. The average unweighted reduction in the Common Equity Tier 1 (CET1) ratios of European banks sampled by Moody's is around 40 bps, before transitional measures.

Most of this impact is due to higher provisions under the IFRS 9 impairment model, which categorizes loans in descending order of quality from "Stage 1" to "Stage 3". Moody's believes that these provisions are largely against Stage 2 loans, defined as those that have deteriorated but are not impaired.

However, there are some big differences across the region. Italian banks show the highest average impact on their CET1 ratios, but due to higher impairments booked on Stage 3 rather than Stage 2 assets. Indeed, at an individual level, more than half of the Italian banks sampled reported reductions in their CET1 ratios, before transitional measures, of more than - 100 bps. In contrast, in the UK and Sweden, the average impact on CET1 ratios was relatively low at about -10 bps and -6bps respectively.

The favourable first time adoption process, along with pressure from supervisors to reduce their problem loans, has given Italian banks a clear incentive to scale-up IFRS 9-related provisions against the impaired loans. This, together with EU transition arrangements, enables them to increase problem loan coverage without booking losses through the income statement, and while maintaining regulatory capital ratios. While apparently paradoxical, this is nevertheless credit positive because the first time adoption has facilitated a more decisive push towards more realistic bad loan valuations and also asset sales, and responds to supervisors' pressure to improve risk profiles.