Banks weather tough climate but brace for new auditing standards

Whereas banks previously relied mainly on historical data to project their impairments, they would now be required to consider the effects of future adverse events and forecasted economic conditions on their loan book upfront (Reuters)

Whereas banks previously relied mainly on historical data to project their impairments, they would now be required to consider the effects of future adverse events and forecasted economic conditions on their loan book upfront (Reuters)

The banking sector has received a relatively clean bill of health, despite a tough economic climate and a slight uptick in impaired advances, according to the 2017 annual report of the South African Reserve Bank’s bank supervision department.

Assets grew by almost 6% year on year to reach more than R5‑trillion, or a “Goldilocks number” of about 130% of gross domestic product, said Kuben Naidoo, the chief executive of the Reserve Bank’s Prudential Authority, at the report’s launch.

This means South Africa has a sophisticated financial sector, Naidoo said, but it is not so big that it presents a risk to the economy.

Although overall loans and advances grew to just over R3.8‑trillion, this growth was slightly slower at 2.5% compared with the previous year’s 3%. Impaired advances grew by 1.9%, going from R106‑billion to R108‑billion.

Naidoo said that banks were reaching the tail end of having to increase their level of capital to comply with international standards. In addition, the economy had been very weak for the past four years, reducing the demand for credit.
The after-effects of the unsecured credit bubble were also still being felt, Naidoo said.

But the ratio of impaired advances to gross loans and advances, a key indicator of credit quality in the banking sector, remained relatively stable, said the report, at 2.84% in 2017 versus 2.86% the previous year.

“Notwithstanding a very difficult economic environment, the banks have been mature and responsible in the way in which they have extended credit, and we think that’s good for security and soundness,” Naidoo said.

The report also provided an update on a major shift in auditing standards for local banks, as they move to implement International Financial Reporting Standard 9 (IFRS 9).

Alongside other regulatory developments such as the “twin peaks” model, which increases regulatory costs for banks, as well as mandatory audit rotation every 10 years and the planned introduction of deposit insurance, banks will have to navigate an increasingly complex and costly terrain.

The introduction of IFRS 9 will have a significant effect on the way provisions for credit losses will be calculated, according to the Reserve Bank, with impairments for at least one of the major banks estimated to increase by about 34%.

Under previous standards, a loss would have to be incurred before a provision was raised against it. But IFRS 9 requires an expected credit loss approach to loans, which takes into account forward-looking macroeconomic information when deciding on the extent of provisions made for credit losses or impairments.

“For example, if the economy is slowing, a bank may have to hold more provisions than it held the last year, even if its loss ratio in the last year was good, and the converse is also true,” Naidoo explained.

The Reserve Bank has been working with the banks to get ready to implement IFRS 9 and, Naidoo said, this is expected to affect their capital requirements. The banks will have to conduct an “education process” on these effects with their investors, Naidoo said.

Standard Bank has released a transition report on the implementation of IFRS 9, indicating that its capital reserves are expected to decline by 3.5% and its impairment provisions to increase by about R8.6‑billion or 34%.

“The introduction of IFRS 9 is all about the timing of the recognition of impairment and will mean that banks will most likely recognise and account for impairments sooner than they have in the past,” said Costa Natsas, a partner at auditing firm PwC.

Whereas banks previously relied mainly on historical data to project their impairments, they would now be required to consider the effects of future adverse events and forecasted economic conditions on their loan book upfront, he explained. 

The standard also requires banks to take a different approach to categorising risk. If the credit circumstances of a performing client loan deteriorate unexpectedly, a bank must immediately make provision for this deterioration and for all future credit losses related to this loan. This may result in higher impairments for such loans, Natsas said.

Implementing IFRS 9 would increase provisions for banks and would also have a marginal effect on their capital reserves, he said.

The new standard could lead banks to reassess their risk appetite, he added, as it may affect what business a bank considers doing in future, such as opting to offer shorter-dated products over longer-dated ones.

“Banks’ views of future economic conditions could also drive the prices of products more directly,” he said.

Mandatory audit firm rotation is expected to add further complexity.

The Reserve Bank will not relax its requirement that systemically significant banks must have two external auditors, despite the Independent Regulatory Board for Auditors (Irba) ruling that all public-interest entities must rotate auditors every 10 years.

He acknowledged that this would be problematic for banks because, for example, the Companies Act prohibits a company from using an auditing firm if it has done any non-auditing or advisory work for that company in the previous five years. However, he said the Reserve Bank was discussing these concerns with the treasury and the Irba.

Client Media Releases

Survey rejects one-sided views on e-tolls
Huawei forms partnerships to boost ICT skills development
North-West University Faculty of Law has a firm foundation
Humanities lecturer wins Young Linguist Award
Is your organisation ready for the cloud (r)evolution?