Fitch: IFRS9 Could Free Up Reserves for GCC Banks
Under IFRS9, when a loan is first made or acquired, it is assessed for expected losses over an initial 12-month period and an up-front provision is booked automatically, triggering an immediate capital hit. Positively for most GCC banks, the impact of having to write provisions up front will not be that significant because they are already used to booking general reserves when they extend new loans.
But even so regulators may not be willing to allow the write-back of existing reserves because they are keen for banks to preserve existing buffers to protect themselves against unexpected losses. We think the toughest supervisors, such as those in Kuwait and Saudi Arabia, are likely to be reluctant to allow banks to cut back on their current high levels of loan loss reserves once IFRS9 is enforced. A compromise between auditors and regulators may have to be reached.
Switching to IFRS9 will be challenging for GCC banks. The absence of a long default history in many countries, coupled with difficulties in correctly assessing collateral values and timeframes for realisations, makes it particularly tricky to assess expected loan losses. Banks are working closely with their auditors and adapting technology and systems to make sure they can plug data gaps to model forward-looking losses.
When IFRS9 comes into force in January 2018, GCC banks will be required to recognise and provide for expected credit losses on loans. They currently report under IAS39, which means they write provisions when losses are incurred, and face supplemental additional requirements set by local regulators. These vary from country to country, but generally mean that banks need to establish general, collective reserves calculated as a percentage of total gross loans and off-balance-sheet commitments.
A 1% general reserve on all on-balance-sheet loans is required in Kuwait (plus a 0.5% reserve on off-balance-sheet exposures) and Saudi Arabia, while Oman differentiates by type of loan, applying a higher 2% reserve for higher-risk personal loans. In UAE, banks need to hold reserves equivalent to at least 1.5% of weighted credit risks - this generally works out at below 1% of gross loans because facilities extended to public sector entities are 0% risk weighted - while Bahrain and Qatar adopt a more bespoke approach.
We consider the Kuwaiti regulator particularly tough and loan loss coverage ratios for the Kuwaiti banks are ample, around 260%. This is due to the Central Bank of Kuwait's unique requirement for additional case-by-case "precautionary" provisions, which depends on the outcome of portfolio reviews.
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