Assessing the Implications of IFRS 9 on Bank Stress Tests

Abstract

IFRS 9 substantially affects the financial sector by profoundly changing the impairment methodology for credit losses. This paper analyzes the implications of the change from IAS 39 to IFRS 9 in the context of financial stability. We shed light on two effects. First, the cliff-effect, which refers to sudden increases in impairments. It occurred under IAS 39, as credit losses were only recognized once they occurred. As a result, impairments often came late and abruptly. IFRS 9 was designed to mitigate this issue by applying a staging approach, which gradually recognizes expected credit losses (ECL) over the lifetime of the loan. This benefit, however, comes at the cost of front-loading impairments, which is the second effect we investigate. The earlier recognition of losses may adversely impact bank resilience by lowering capital levels. It remains to be seen, whether the conjunction of both effects constitutes a net benefit for the financial sector. We empirically investigate this question using the European bank stress test from 2014 to 2018. It is a natural experiment, in which all banks are subject to the same regulations and exogenous shocks. This characteristic allows us to control for otherwise immeasurable effects and to reveal the true implications of the ECL model in light of the cliff-effect as well as the front-loading effect. Furthermore, the calculation of a baseline and an adverse scenario allows us to investigate the vigorousness of procyclicality under IFRS 9 compared to IAS 39.