As governments, society and corporates respond to the threat and management of COVID-19, many challenges are arising for banks including loan loss reserving and the behaviour of IFRS 9 in an uncertain and volatile environment.

Regarding the timing of recognition of losses, firms should consider the forward-looking information that they had available at the relevant balance sheet date. For instance, for European firms with a 31st December year end, little was known about the virus at that point; it was not expected to have a significant future impact and firms could reasonably have considered that the impact of the virus was captured in their stage allocation and scenario weighted ECL outcomes.

Today the situation is much more challenging. Firms should be thinking about reviewing their scenarios, their weightings and the effects of any changes in forward-looking view on PDs, LGDs, staging and ECL, which we would expect to lead to a more adverse outlook, higher Stage 2 balances and increased ECL. It may be that firms consider they already have scenarios that give rise to appropriate loss outcomes, but that their weightings need reviewing. Alternatively, firms may choose to develop new scenarios reflecting a more specific view of the economic and loss consequences of the virus given new information.

Firms should also consider their regular reporting cycle, typically quarterly for large firms and semi-annually for smaller firms. Should they re-assess, for instance, whether ECL should be updated on a more frequent basis given the speed of developments in the political and societal management of the crisis and the reaction in financial markets? Some firms have lengthy recalibration processes, where accurate quantification of the impact of new scenarios and weightings on the ECL output can take between one and two months. Although some firms are investing to make these processes quicker and more robust as part of IFRS 9, embedding this will take time. Firms should consider their use of higher-level “rule-of-thumb” tools to quickly estimate impact to ensure that management and Boards are well informed about potential balance sheet consequences.

As a result of the disruption caused by COVID-19, firms are likely to increase their use of forbearance. US regulators have urged firms to work “constructively” with borrowers and press reports suggest that the Italian government is requiring lenders to suspend mortgage payments and other household bills during the outbreak. There have also been announcements from individual lenders. The correct reporting of such concessions as defaults or as forbearance (either preforming or not) is important and likely to lead to an increase in Stage 2 balances, Stage 3 balances and ECL. From an accounting perspective, firms will have to consider whether such changes constitute a significant modification.

Similarly, firms will need to consider how new facilities to a customer in financial difficulty should be classified - if they do not qualify as a distressed restructure, and are within lending policy, they would likely be classified as Stage 1, even given the precarious situation of the borrower.

Lastly, firms should consider whether signals from market information should lead to individual corporate or wholesale exposures being moved to Stage 2 or, indeed, whole sectors/geographies e.g. the tourism and leisure sector has fallen significantly.

Since IFRS 9 was introduced in 2018 the credit environment has been relatively benign, yet IFRS 9 was designed to respond to fast moving changes in expectations of economic conditions. This is the time that firms’ rating systems will need to withstand such changes and in doing so produce meaningful information to investors and regulatory authorities.