EBA Sounds Alarm: The European Banking Authority (EBA) has raised serious concerns about the banking sector’s failure to adhere properly to the International Financial Reporting Standard 9 (IFRS 9). This accounting rule was instituted as a response to the pivotal lessons learned from the global financial crisis of 2008. The second report from the EBA reveals persistent shortcomings in the implementation of IFRS 9, particularly in terms of timely and adequate provisioning for loans at risk.
IFRS 9, a global accounting rule, mandates that loans on a bank’s balance sheet should be evaluated against prevailing market prices, recognizing a portion of any expected loss over the upcoming 12 months. The rule also requires upfront provisioning, especially if there’s a significant increase in credit risk, indicating a potential loan default. The proper application of IFRS 9 is crucial for regulators to ascertain whether banks have made sufficient provisions, ensuring they maintain the necessary capital levels.
The EBA’s latest findings come at a critical juncture when borrowers are grappling with repayment difficulties due to the rapid rise in interest rates from historically low levels, making loans more expensive. The EBA emphasizes that supervisors in EU member states will diligently follow up on the main findings outlined in the report.
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One major issue highlighted in the review is the prevalence of “adjustments” or “overlays” employed by banks, where they use their judgment to tweak results derived from their risk models. Such practices can potentially delay the transition to full provisioning, raising concerns about the adequacy of banks’ risk management frameworks. The report also points out discrepancies in the consideration of risks, calibration approaches, and the level at which overlays are applied. This lack of uniformity across banks could hinder the reflection of additional sources of risk, potentially impacting the accuracy of risk assessments.
Additionally, the EBA expresses concerns about the reluctance of banks to conduct “collective” assessments of risks across a portfolio of loans, especially when there’s limited risk data available for individual loans. This reluctance, deemed a prudential concern, underscores the need for banks to adopt a more comprehensive approach to risk evaluation.
The review highlights the importance of backtesting, a process that assesses the accuracy of applying IFRS 9 and determines whether expected loss models need recalibration. The EBA calls for improvements in this area, emphasizing the critical role it plays in ensuring the integrity and reliability of the provisioning process. The EBA’s report serves as a wake-up call for banks to address the identified shortcomings promptly. The regulatory body urges systemic changes to enhance the effectiveness of risk management practices, ensuring the resilience of the banking sector in the face of evolving economic challenges.
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