* Analysts warn of 300bp capital hit in downturn
* Banks unhappy with interaction between Basel framework and IFRS9
* "Mother" of IFRS9 says system leaves "no more excuses"
By Tom Porter
LONDON, Jan 12 (IFR) - Analysts have warned the IFRS9 accounting rules slated for 2018 will increase volatility in bank earnings and capital, but the former Goldman banker tasked with drawing up the new standards told IFR they are vital to preventing another crisis.
IFRS9, due to come into force on 1 January 2018, will require banks to provision against expected losses on loans rather than wait for a default event, a sea change for European lenders in particular.
The new accounting standard is completely separate from the Basel Committee's post-crisis Basel III capital framework, but market participants fear it will have the unintended consequence of eroding banks' capital ratios.
"Capital headwinds in a downturn could be much more severe under IFRS9," Barclays analysts wrote in a note on Monday, adding that the changes could knock as much as 300bp off industry-wide common equity tier 1 ratios during a typical downturn. This would be around three times higher than under the current system.
"There will be plenty of instances when IFRS9 appears to smooth bank earnings," they said. "But in a bad enough downturn - or where there's a swift enough deterioration in credit quality - the provisions taken in good times won't be enough to cope."
Under IFRS9 banks will take a provision charge immediately on each new loan based on its 12-month expected loss, and will then take a further lifetime expected loss provision if there is a "significant deterioration" in asset quality.
The warnings come as many question how IFRS9 will interact with the Basel III capital framework, which was due to be finalised by end-2016 but has dragged into this year because of a disagreement over limits on internal credit risk modelling.
At the moment Basel is not planning to alter those rules to accommodate the impact of IFRS9, though in October it proposed phasing in the capital impact over three to five years after January 2018.
"Basel's work on the phase-in impact of IFRS9 was, in hindsight, a missed opportunity for them to also address issues of pro-cyclicality," said the Barclays analysts.
"But there is still time."
But for Sue Lloyd, vice-chair of the International Accounting Standards Board, the focus is on developing a global framework that allows banks to react more quickly to deteriorating asset quality.
"Our job is not to get involved in a discussion on appropriate bank capital levels with the Basel Committee," she told IFR, "though we do have a close relationship with prudential regulators because we all care about financial stability."
Lloyd, a former Goldman Sachs managing director, now widely referred to as the "mother of IFRS9" - not a name she encourages - says her team was "shocked" by the difference in application of accounting rules globally when they started looking at the issue post-crisis.
"For example, Australian banks' application was closer to an expected loss model than in other jurisdictions," she said.
"And despite the accounting requirements under US GAAP and IFRS standards being basically the same, the actions of US prudential regulators led to much larger provisions being booked in the US."
Many market participants dislike IFRS9 because even though banks are increasing what they set aside to cover losses, this is not reflected in their headline capital ratios.
An impact assessment by the European Banking Authority in November 2016 claimed CET1 ratios will decrease 59bp on average, and up to 75bp for 79% of its survey respondents.
One suggested solution is for the European Central Bank to decrease a bank's Supervisory Review and Evaluation Process (SREP) requirement - a minimum capital level it assigns each bank - when its provisions rise.
Under the current IAS39 accounting regime, banks' expected losses are typically higher than what they have provisioned for, with the capital shortfall deducted from their CET1.
This will not change under IFRS9, according to the Basel Committee's guidance to banks on implementing the new rules.
However, if provisions exceed expected losses, which is a possible outcome of IFRS9, banks are rewarded with a boost to their Tier 2 capital, instead of a CET1 add-on.
While this increases the institution's total capital, banks feel they do not fully benefit from it because investors care more about CET1 - the core capital ratio under Basel III which is now widely used to compare banks with their rivals.
Lloyd points out that the IASB consulted widely with the industry on IFRS9, publishing three full drafts of the rules and a discussion paper before its finalised document in July 2014.
During the crisis loan loss impairments came too little, too late, she said.
"Banks were not allowed to book losses without an actual loss event occurring and even then, you could only use historical data and current circumstances - you weren't allowed to use house price forecasts, for example."
"Under IFRS 9 there will be no more excuses - you have to use all the information you have available to judge potential losses from day one." (Reporting by Tom Porter, editing by Helene Durand, Alex Chambers)