New accounting standard will make loans, insurance expensive

Experts say financial institutions to prefer extending short term loans. New accounting standard will make loans, insurance more expensive

Kampala, Uganda | ISSAC KHISA | Uganda’s banking and insurance industries are envisaging good times ahead as they embrace the new global accounting standards effective this year.

The bad news is that borrowers and insurance buyers are going to find it more stressful to acquire long terms loans or debt facilities as the two industries increase scrutiny of their activities and requirements for worthy collateral.

The new accounting standard known as International Financial Reporting Standard 9 or IFRS 9, which came into effect last month, requires banks and insurance companies to make appropriate provisions in anticipation of future potential losses, rather than the former practice, International Accounting Standard 39 (IAS 39) , of providing provisions only when losses are incurred.

This signals that banks as well as insurance companies that offer their policy covers on credit will have to recognise provisions from the day they extend any loan or service or credit to minimise losses that could lead to their collapse.

For that, financial experts say the cost of accessing loans and other financial services on credit are expected to go up as banks and insurance companies make potentially higher provisions, especially for clients with high credit risk profiles to cover up potential credit losses.

Financial institutions will also restructure their credits, emphasising short term loans compared with long terms loans to minimise chances of default, says Paddy Mugambe, a consultant on Financial Management at the Uganda Management Institute.

“Additionally, financial institutions will reduce unsecured loan facilities to customers within the transition stage of IFRS 9 replacing IAS 39,” he told The Independent in an interview.

Mugambe said financial institutions will also see reduced profits being reported due to higher credit provisions being recognized, a situation that could lead to capital depletion in the short run.

He said the new reporting standard will drive credit facilities towards sectors or industries that are doing well and less to those sectors or industries suffering, a scenario that would see various sectors that are deemed riskier experience stagnation in growth.

In the long run, however, Mugambe says the new reporting standard will enhance and improve on their client screening processes before the extension of especially long term loans and this will most likely reduce on the default rates on such loans.

“The new standard will also lead to increased efficiency owed to the need to review the expected credit loss annually with a view of avoiding use of life expected credit loss,” he said, adding that the new financial standard will ensure that banks and insurance companies are adequately capitalised.

The development of the IFRS 9 in 2014 by the London-based International Accounting Standard Board (IASB), was in response to the 2008/9 global financial crisis in which financial institutions were unable to book accounting losses until they were incurred even when they could see them coming.

The new standard deals with accounting for financial instruments such as loans and advances, customer deposits, government securities, cash, borrowings, other debtors and creditors as well provides guidance in classification and measurement, impairment and hedging of these financial instruments. This is to ensure that financial institutions recognise and account for risk more prudently.

The IFRS 9 also introduces a new requirement of calculating credit risk associated with credit and overdraft limits, letters of credit, performance and financial guarantees and requires that institutions recognise risk of default at the beginning and during the entire credit life cycle.

“Financial sectors especially banking has been vibrant with extending loans that do not need collateral security,” Frederick Kibbedi, the vice president of the Institute of Certified Public Accountants of Uganda (ICPAU) told The Independent.