Westpac will book an impairment charge of A$2.2 billion when it releases its half-year financial report next Monday. The charge includes $1.6 billion of forward-looking adjustments related to COVID-19.
The bank said the charge would reduce its common equity tier 1 capital ratio by 11 basis points. Its CET1 capital ratio at 31 March is expected to be 10.8 per cent. Its impairment charge in the March half last year was $333 million.
Westpac’s announcement comes a day after NAB booked an impairment charge of $1.16 billion in its half-year financial report, which included an $807 million increase in the forward-looking economic adjustment due to the potential deterioration in broader macro-economic factors as a result of the COVID-19 pandemic.
The two forward-looking adjustments show considerable variation in the banks’ use of the IFRS 9 accounting standard, which was introduced after the financial crisis to shift provisioning from an incurred loss model to an expected credit loss model.
The International Accounting Standards Board introduced IFRS 9 in 2014 (it was adopted in Australia as AASB 9) and it took effect in 2018. The COVID-19 crisis is the first opportunity investors have to see how the expected credit loss model will apply in a serious economic downturn.
Westpac said the $1.6 billion of additional charges was based on three elements: significant changes to base case economic forecasts; increasing the weighting applied to the downside economic scenario; and an overlay based on industry-by-industry assessment of additional stress that could emerge in relation to COVID-19.
This is not dissimilar to NAB’s approach. In its financial report it presented a base case economic scenario, a severe downside scenario and its final outcome based on “probability weighted” assumptions. It also presented sensitivities in several major sectors, such as retail trade and commercial real estate.
The widely varying outcomes - $1.6 billion versus $807 million – are a reflection of the banks’ balance sheets and their exposures to different sectors of the economy. They are also a reflection of their different interpretations of IFRS 9.
Under IFRS 9, as soon as credit is originated or purchased, banks are required to recognise provisions based on 12-month expected losses. These are referred to as “stage 1 loans”.
Once a loan has experienced a “significant increase in credit risk” or is impaired, it should be moved to stage 2 or 3 with provisions based on lifetime expected losses.
In guidance published last month, the IASB said IFRS 9 does not set “bright lines” or a mechanistic approach to determining when lifetime losses are required to be recognised.
“Nor does it dictate the exact basis on which entities should determine forward-looking scenarios to consider when estimating expected credit losses,” it said.
“IFRS 9 requires the application of judgement and allows entities to adjust their approach to determining expected credit losses in different circumstances. Entities should not continue to apply their existing ECL methodology mechanically.
“For example, the extension of payment holidays to all borrowers in particular classes of financial instruments should not automatically result in those instruments being considered to have suffered a significant