30 Questions
What did IFRS 9 introduce that brought many challenges to banks?
Expected credit loss model
Why can't banks use the simplified approach for recognizing loss allowances on loans under IFRS 9?
Loans do not fall within the exception
Under IFRS 13, what determines whether a financial asset is classified as amortized cost, fair value through profit or loss, or fair value through other comprehensive income?
Assessment based on specific tests
What type of financial assets can majority of companies use a simplified approach for under IFRS 9?
Loans
What major challenge does the impairment of financial assets bring to banks under IFRS 9?
Application of a 3-stage general model
Which type of companies cannot use a simplified approach for impairment of loans under IFRS 9?
Banks
What is the focus of IAS 19 Employee Benefits?
All of the above
What is a major difference in the assets and liabilities of banks compared to non-financial firms?
Banks' assets and liabilities are financial contracts
What is a key aspect of financial instruments that is highlighted in the text?
Risks like credit risk and market risk
Which financial reporting standard is particularly crucial for financial institutions due to its focus on 'fair value' accounting?
IFRS
What plays an important role in financing productive investment opportunities according to the text?
Banks
How do valuation rules based on 'fair value' accounting under IFRS impact banks' solvency?
They drive the markups or markdowns, altering solvency
What type of risk is NOT mentioned in relation to financial instruments in the text?
Operational risk
How do money transactions typically relate to most non-banking companies?
Money transactions are supporting transactions for most companies
What does the text suggest may shift some contracts from off-balance sheet to the balance sheet?
Employee benefits with reduced beneficial interest rate
What distinguishes the financial statements of banks from those of corporations?
Nature of assets and liabilities
Which accounting standard is specifically mentioned in the text regarding hedge accounting?
IFRS 10 Consolidation
Why are off-balance sheet commitments of banks highlighted as significant in relation to their balance sheets?
Off-balance sheet commitments can be of comparable size to balance sheets
What formula is used to calculate loan loss provision for the current period?
Current LLP - Previous Day's LLP
How is the loan loss provision rate determined?
Based on the overdue tenor/maturity group and risk attached
What does a high Loan Loss Provision Coverage (LLPC) ratio indicate?
Greater ability to absorb loan losses
How are loan loss reserves and supervisory capital requirements related?
Both are linked to the level of risk in a bank's financial positions
What are loan loss reserves intended to cover?
Expected losses based on historical experience
What covers losses that are considered 'unexpected' according to the text?
Loan Loss Reserves
What does it mean when loan loss or write-offs occur as accounting entries?
They represent entries to account for potential losses in the loan portfolio
Why should the Loan Loss Provision (LLP) not be less compared to expected future losses?
It ensures that the estimated probable losses can be absorbed
Why are reviews necessary for representing losses on a balance sheet date?
To accurately reflect the estimated probable losses in the loan portfolio
What does analyzing the borrower's industry, such as Agriculture, Mining, or Tourism, help with?
Estimating the borrower's ability to repay the loan
How does the quality of credit policies and procedures affect loan portfolio evaluation?
It helps in setting aside allowance for potential losses
What is the primary factor considered when determining the amount of allowance that must be set aside for potential losses?
Past loss experience
Study Notes
Impairment of Financial Assets
- IFRS 9 introduced expected credit loss model for recognizing loss allowance to financial assets in July 2014
- Banks are severely affected by IFRS 9 and cannot use simplified approach for impairment of financial assets
- Banks need to apply 3-stage general model for recognizing loss allowances
Measurement IFRS 13
- Financial assets can be classified into three categories for measurement:
- Amortized cost
- At fair value through profit or loss (FVTPL)
- At fair value through other comprehensive income (FVOCI)
Impact of IFRS on Banking Sector
- Banks' financial statements follow the same basic principles as those of corporations, but with major differences
- Assets and liabilities of banks are financial contracts, and banks' capital is smaller compared to the size of the balance sheet
- Off-balance sheet commitments of banks have a size comparable to their balance sheets
Banking Industry
- Banking industry is heavily regulated
- International Financial Reporting Standards (IFRS) are of major importance for financial institutions due to their focus on "fair value" accounting
Financial Statements of Banks
- Financial statements of banks differ widely from those of corporations
- Focus is on significance of financial instruments, risks attached to financial instruments, and transfers of financial assets
Consolidation and Special Purpose Entities
- IFRS 10 and IFRS 12 are relevant for consolidation and special purpose entities
Other Issues to Watch Out
- Leases may not be called "lease" but may have a substance of a finance lease
- Employee benefits, such as "employee loans" and contributions to pension funds, need to be considered
- Hedge accounting requires specific conditions to be met, including hedge documentation
Loan Loss Provision
- Loan loss provision (LLP) should be maintained at a level believed to be sufficient to absorb estimated probable losses inherent in the bank's loan portfolio
- Factors to consider when evaluating a loan portfolio include:
- Past loss experience
- Quality of management in the lending area
- Loan collection and recovery practices
- Quality of credit policies and procedures
- Loan growth
- Financial conditions of the borrower
- General economic trends
- Borrower's industry
- State of the economy
Loan Loss Provision Calculation
- LLP for the current period = LLP calculated as of day - previous LLP
- Loan loss provision rate is determined by the overdue tenor/maturity group, based on risk attached to each class
Loan Loss Provision Coverage Ratio
- Loan loss provision coverage ratio (LLPC) shows the ability of the institution to absorb any loan losses that may be encountered
- LLPC = Pre-tax income + loan loss provision / Net off charges
Loan Loss Reserves and Regulatory Capital
- Loan loss reserves and supervisory capital requirements are directly linked
- Loan loss reserves are intended to cover losses that are expected to occur based on historical experience, adjusted for changes in the economic environment
Test your knowledge on the significance of financial instruments, accounting policies, risks like credit risk, market risk, and liquidity risk, transfers of financial assets, consolidation, special purpose entities under IFRS 10 and IFRS 12, and other related topics like leases.
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