Opening remarks by Francois Groepe,
Deputy Governor of the South African Reserve Bank,
at the workshop on the impact of IFRS 9 on banks and regulators in Africa,
jointly hosted by the Working Group on Cross-border Banking Supervision
and the South African Reserve Bank
South African Reserve Bank, Pretoria
26 September 2017
Introduction
Good morning, distinguished guests, ladies and gentlemen.
It gives me great pleasure to warmly welcome you to this workshop on the impact of
International Financial Reporting Standard (IFRS) 9 on banks and regulators in Africa,
which the South African Reserve Bank (SARB) is hosting jointly with the Working Group
on Cross-Border Banking Supervision.
I would like to thank the Association of African Central Banks and, in particular, the
Working Group on Cross-Border Supervision of the Committee of African Banking
Supervisors for being present here today. We are indeed privileged to host fellow central
bankers and regulators from across the African continent to discuss matters relating to
the implementation of IFRS 9. The SARB truly values the cooperation with its peers from
the continent and opportunities like this allow us to nurture networks and build
relationships, share experiences and learnings, and contribute towards improving the
continent's
overall quality of our prudential supervision of the financial sector.
Financial reporting
It is believed that Luca Pacioli, a Franciscan monk known as the father of accounting,
was the first to codify the double-entry system of bookkeeping in his mathematical
textbook titled Summa de arithmetica, geometria proportioni et proportionalita which was
published in Venice in 1494. The celebrated German writer Johann Wolfgang von Goethe
sang the praises of this system and described it as the finest invention of the human mind
as it allowed the merchant to survey the whole of his business activities at any time; he
that 'every prudent master of a
even suggested house should introduce it into his
economy'.
As any system, however, this system also has its challenges and shortcomings, and the
renowned investor Warren Buffet warns that financial accounting is an imperfect language
and that to understand accounting one needs to understand its nuances. Buffet further
warns that, 'in the long run, management's stressing of accounting appearance over
economic substance usually achieves little of either'. It is therefore critical that, to extract
the most from the system of financial accounting, one is mindful of the inherent
shortcomings of the system.
In order to address some of the challenges in this area, much progress has been made
towards the ideal of developing a set of high-quality international accounting standards
that are widely used. In this regard, international standard-setting bodies, such as the
International Financial Reporting Standards Foundation, play a vital role in working
towards this goal. This Foundation has as its mission the development of standards that
bring transparency, accountability, and efficiency to financial markets around the world
and serving the public interest by fostering trust, growth, and long-term financial stability
in the global economy. The International Accounting Standards Board (IASB), an
independent private sector body which was established in 2001 and operates under the
oversight of the International Reporting Standards Foundation, has been tasked with the
development and approval of IFRSs, as well as the issuing of interpretations of these
IFRSs.
IFRSs are now required in 125 jurisdictions and South Africa too subscribes to the
accounting standards issued by the IASB, as do many of the jurisdictions represented
here today. Irrespective of whether your respective jurisdiction has adopted IFRS or not,
I am sure that all of you will find benefit from the discussions and presentations that will
take place during this workshop.
IFRS 9 and the G20
On 24 July 2014, the IASB issued a new accounting standard on financial instruments
called IFRS 9, which replaced the existing standard, namely International Accounting
Standard (IAS) 39, and which has a mandatory effective date of 1 January 2018. IFRS 9
inter alia specifies how an entity should classify and measure financial assets and
liabilities. One of the fundamental changes that IFRS 9 introduces is the concept of
Expected Credit Loss (ECL) provisioning. This new principle replaces the current incurred
losses model and will materially change the way in which companies, and in particular
banks, are required to approach and account for impairments for credit losses.
According to the Bank for International Settlements (BIS), the great financial crisis of
2007-09 highlighted the systemic costs of a delayed recognition of credit losses on the
part of banks and other lenders, and the application of the prevailing standards at the time
was seen as having prevented banks from provisioning appropriately for credit losses
likely to arise from emerging risks. These delays resulted in the recognition of credit
losses that were widely regarded as 'too little, too
late', and gave rise to questions of
procyclicality by spurring excessive lending during the boom and forcing a sharp reduction
in the subsequent bust.
The development of the ECL accounting framework is consistent with the call by the
leaders of the Group of Twenty (G20) in April 2009 to strengthen accounting recognition
of loan loss provisions by incorporating a broader range of credit information. One of the
consequences of this new framework is the fact that while, in the past, a loss event had
to have occurred before an impairment was raised by a bank. The standard now requires
that loss provisions be raised earlier and take into account not only past and present
information but also forward-looking information, which emphasises the future probability
of credit losses in determining them. This standard is aimed at resolving the weaknesses
identified during the global financial crisis of 'too little, too late' referred to above, and this
will hopefully result in a more robust financial system that is more resilient and hence
better able to withstand shocks.
The adoption of IFRS 9 will give rise to higher levels of credit impairments. A study
undertaken by the European Banking Authority estimated that the implementation of
IFRS 9 would give rise to an average increase of 13% in loss provisions compared to the
current levels under IAS 39; it is further expected that the Core Equity Tier (CET) 1 ratios
will decrease by an average of 45 basis points. Smaller banks, which mainly use the
standardised approach to measuring credit risk, estimate a larger impact on their own
fund ratios than the larger banks. Estimates of the exact impact differ, however, and only
time will tell which of these estimates was accurate.
There are those that argue that the adoption of IFRS 9 may in fact increase procyclicality,
because during recessionary conditions there may be a sharp fall in CET 1 capital levels
and this, in turn, may lead to a sharp easing in credit extension due to the so-called 'cliff
effect' of the staged approach prescribed by IFRS 9. Others, notably the BIS, reject this
argument on the basis that banks, after the global financial crisis, are now better
capitalised with higher buffers and thus are better able to absorb losses. They further
banks'
argue that the early loss recognition of credit losses enables a quicker 'clean-up' of
balance sheets, thus enabling them to support economic recovery.
This debate is clearly not yet settled and we will need to wait and see how this plays out
during the next recession. The economic impact is, however, not only limited to the level
of losses and the timing of the recognition; the implementation of IFRS 9 is also likely to
impact on the pricing of products which may thus impact on overall credit extension within
the economy and ultimately consumption and hence economic growth.
likely that banks' earnings will be more volatile in
It is furthermore the future due to the
effect of the forward-looking approach that is required under IFRS 9. Therefore,
disclosure and the education of stakeholders on how to interpret financial information
under IFRS 9 will be imperative and an important consideration.
Over the past two years, many seminars, workshops, and training sessions have been
provided by a range of organisations. However, very few of these have focused on
jurisdictions from the African continent. There are factors that are unique to Africa that
need to be taken into account. With this workshop, we want to fill this gap and provide a
platform for African regulators to discuss the specific issues and concerns that may affect
them in the implementation of IFRS 9. In this context, we are very much looking forward
to the presentation from the Bank of Zambia on its in-country regulator perspective.
Auditors
The BIS correctly points out that the effectiveness of the new standards will not only
depend on how banks implement them but will also depend on the contributions of central
banks, supervisors, and other stakeholders, such as auditors. The BIS highlights that
supervisors can play a very important role in promoting sound bank implementation
practices through their banking supervision activities in a manner that complements the
efforts of accosting standard setters.
The auditing profession, as mentioned, is an important stakeholder when it comes to the
implementation of IFRS 9, so a discussion of IFRS 9 would not be complete without
reference to their role. There is little doubt that the audit profession is likely to be
challenged with the introduction of IFRS 9. The reason is that the audit of accounting
estimates, such as impairments, has always been a very complex area and the
introduction of IFRS 9 will further add to that complexity.
We are extremely pleased to have multiple representatives from the audit profession in
our midst today and tomorrow. We will listen to presentations from both PwC and KPMG
dealing with audit expectations, while EY will provide us with their perspective during the
panel discussion tomorrow. We especially want to welcome the representatives from PwC
Kenya who will be sharing with us their experience to date.
Before I conclude, I would like to touch on two audit-related topics, namely mandatory
audit firm rotation and the recent developments that engulfed the global audit firm KPMG.
The Independent Regulatory Board for Auditors (IRBA) recently issued a new rule on
mandatory audit firm rotation, which limits audit firm appointments to a maximum period
of 10 years. The efforts by IRBA to improve independence are to be welcomed. The SARB
has been proactive with regard to auditor independence, for example section 61 of the
Banks Act provides that the Registrar of Banks must approve the appointment of an
auditor before such an auditor can take up office. Such an appointment further requires
that the Audit Committee do a proper assessment of the suitability of the auditor to hold
office, after which the Office of the Registrar of Banks would also do a fit and proper
of the auditor's
assessment prior to the approval appointment.
The SARB, from a supervisory perspective has furthermore, for many years now, required
large banks to appoint joint auditors as this further reduces the independence-related risk.
The SARB therefore, while broadly supportive of the principle of mandatory audit firm
rotation, believes that banks should be exempted from these requirements as our
supervisory standards and practices as it relate to auditor independence far exceed those
that have recently been put in place. We further believe that the maximum period of
appointment should be increased from the proposed 10 years to a longer period of
between 15 and 20 years, as individual audit partner rotation is already in effect. The
challenges around skills shortages are furthermore a reality that may act as an obstacle
to achieving this objective of rotating audit firms after 10 years.
If mandatory audit firm rotation is retained in the current form, the SARB may be
compelled to revisit the requirement of joint auditor appointments for large financial
institutions due to some of these practical considerations. Although the removal of the
requirement of joint auditors for large financial institutions will lead to reduced audit fees
and other efficiencies, we believe that this is likely to weaken auditor independence and
may detract from the current high levels of audit quality and thus possibly erode the
effective oversight and supervision of banks. This would not be in the public interest. We
further remain unconvinced that mandatory audit firm rotation represents an effective
policy intervention to address the stated secondary objectives of redressing the high
levels of market concentration and to promote transformation within the auditing
profession.
As a regulator, the SARB as a rule does not comment on individual firms. We, however,
took the extraordinary step to comment publicly on the developments surrounding KPMG
last week as they are the auditors to three of the big four banks, as well as to other banks
and insurance companies. Our interest stems solely from a public policy perspective that
arises from our financial stability mandate. We had noted with concern the regrettable
auditing practices and serious errors of judgment that had occurred at KPMG and which
had led to significant damage being inflicted on certain individuals, organisations, and the
country as a whole.
During our engagement with the local and global leadership of KPMG, we have noted the
increasing and firm commitment of the new management team to fully own up to past
mistakes and to work towards restoring the public trust. The recent announcements in
this regard are recognised as important first steps towards this end and we are eagerly
awaiting the results of the independent investigations undertaken by IRBA and the more
recently announced one by KPMG. As a regulator, we do not pick winners or losers, but
we are concerned stemming from our extensive experience of regulating banks this
unfolding situation may take the form of a bank run with contagion risk that extends
beyond an individual firm. This situation calls for thoughtful leadership and restraint as we
believe that our economy will be better served if we can avoid further market
concentration within the auditing and auxiliary professional services sector.
These recent developments have, however, provided us cause to pause. In the coming
months and years, the following policy considerations may need to be pondered in the
interest of further strengthening governance and transparency within the auditing and
accounting professions. These include:
The requirement that audit firms may be 'too big to fail' and whether this may
(i)
require regulatory intervention, including limiting the extent to which audit firms
provide non-audit services, especially to audit clients. The imposition of caps
regarding the value of non-audit services rendered to audit clients and prohibiting
the rendering of certain category of non-audit services to audit clients in line with
the reforms announced by the European Commission in 2016 should enjoy serious
consideration.
(ii) A far greater degree of disclosure and transparency by the auditing and accounting
profession are required, given the public functions that audit firms perform when
they inter alia attest the financial statements of public companies. Hence,
consideration should be given to making the full public disclosure of a
comprehensive set of audited financial statements mandatory, irrespective of the
form or legal structure of ownership of such firms.
(iii) The appointment of independent boards of directors and the strengthening of the
risk management function within audit firms will further strengthen oversight and
governance within auditing and accounting firms.
(iv) The publication of an integrated report by the large and medium size audit firms as
this may contribute to improve transparency around transformation initiatives and
could assist to accelerate transformation within this sector. Full disclosure
regarding compliance with governance frameworks such as King IV could also
assist in improving governance arrangements within these firms.
While this list is not exhaustive, it would be useful if there were a public discourse around
these policy questions. We firmly believe that the implementation of some of these
proposals may go some way to strengthening the governance within the audit and
accounting professions and could assist to further support and possibly strengthen the
trust that society places in them.
Conclusion
The saying goes that change is the only constant in life. IFRS 9 certainly represents a
major change for the banking industry. It is certainly a change that needs to be embraced.
The regulated sector will be looking towards their regulators for guidance, hence we need
to be up to date and well versed in order to be able to provide effective guidance. To this
end banks, auditors and regulators will have to work together to ensure that the
implementation of IFRS 9 will be a success. I hope that this workshop will contribute
towards this goal.
I am sure that during the next one and a half days, there will be very interesting and fruitful
discussions that will benefit all the jurisdictions present here today and even after the
workshops, I am sure conversations will continue. I wish you well on your IFRS 9
implementation journey and hope you will enjoy the workshop.
Thank you.