The introduction of new accounting rules is likely to boost provisions for credit losses among Canada’s Big Six banks, reduce their capital positions, and to heighten earnings volatility, says a commentary released Thursday by Toronto-based DBRS Ltd.
Beginning on Nov. 1, 2017, the banks will begin reporting under International Financial Reporting Standard 9 Financial Instruments (IFRS 9).
This new accounting standard will change how the banks “establish and record their allowance for credit losses”; and will affect the flow of their credit loss provisions, the DBRS report says.
“Overall, the new expected credit loss model under IFRS 9 aims to make credit loss accounting more responsive to expected changes in the macro environment by enabling banks to be more proactive in building up credit loss provisions in advance of an expected economic slowdown,” the report says, noting that this change was prompted by the financial crisis.
DBRS does not expect the adoption of the new standard to impact the banks’ creditworthiness. However, the new approach to accounting for credit losses is expected to increase provisioning by banks, and could lead to greater volatility in quarterly earnings, the report says.
With the new rules taking effect, DBRS says that the big banks are expected to increase their collective provisions on their opening balance sheets for fiscal 2018, “which will be recorded as a charge to retained earnings.”
The full impact of this new accounting standard will be reflected in the banks’ financial results for the first quarter of 2018, the report says. For smaller banks, the new standard won’t be implemented until fiscal 2019.
“Adoption of IFRS 9 will likely lead to an initial negative impact on capital ratios of the large Canadian banks and has the potential to increase earnings volatility going forward,” the report says. “The impact on each of the banks is not expected to be the same given differences in factors such as their geographic footprint, duration of assets and loan mix.”
Despite the expected impact on the banks’ financials, DBRS does not expect the new standard to negatively impact their credit ratings.