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Transition to IFRS – Process and Challenges for Core Banking Systems

July 6, 2018 - Swapnil Agarwal Senior Consultant, Finacle Product Group

The financial environment is in a state of constant flux and warrants a change in regulations that govern it. One such regulation is IFRS i.e. International Financial Reporting Standards. The regulation is much broader in scope than what the name suggests. This set of new regulations encompasses a major change in internal accounting of banks while paving a paradigm shift in their risk management processes. IFRS has already been adopted by many countries w.e.f. Jan 1, 2018, and many others in South Asia and South East Asia will be embracing the new regulation in the coming months. This transition from the existing GAAP to IFRS calls for major alterations and additions in the Core Banking Systems of banks in myriad ways.


Transitions are not always easy and this one certainly comes with a rather complex set of challenges. This impact can be analyzed in the light of the new features being introduced in the IFRS regime. This paper looks at 3 key areas, the required transition process and the associated challenges, starting from simple changes to the more complicated and intricate ones:

  1. Categorization of all accounts

    The Regulation
    IAS39 required classification of assets into four categories while IFRS9 requires all customer accounts in Core Banking System to be categorized in one of the following three categories-

    These categories are similar to the IAS39 asset classifications of – Held till maturity, Available for sale, Held for trading and Loans & receivables. The erstwhile classifications have been merged to create three new categories. Since very few banks have been classifying their accounts as per the oldr categories (most of those who practiced IAS provisioning and classification), to most of the banks and CBS, this is altogether a new feature. Moreover, the earlier set of account classifications were meant mainly for MIS purpose and had no accounting impact. However, the IFRS categories call for specific accounting behavior for fair valuation and for any category change, accounting entries are required to be passed. In the absence of these processes, banks would end up posting wrong figures in their books of accounts.

  2. Transition Process

    Firstly, this feature would require Banks to draw out their policy pertaining to rules for categorization of customer accounts. IFRS9 categories, being a new feature, will require banks to list out all their customer accounts and tag them to their respective applicable category in a text file or excel sheet. The system would be required to update these values against all such accounts as a one-time activity as on the date of transition. There shall be no accounting required in this process. Categorizing new accounts as and when opened, or re-categorizing old accounts into any other category should be handled once banks’ CBS fully transitions to adopt the IFRS platform.

    Banks would face the challenge of drawing rule-engine for account categorization, basis the business model and SPPI test. Once that is done, listing and updating should be manageable.

  3. Fair Value

    The Regulation
    With increasing risk propositions in the financial world and complex financial products, banks are becoming more and more vulnerable to financial defaults. IFRS9 brings forth ‘measurement of assets at their fair value’ as one of the anti-dotes to avert these events. Under this mechanism, all assets require to be measured at their fair value. This value is a sum of their contracted / expected cash flows discounted at current market rate. Fair value of conventional assets (held-till-maturity type – categorized as Amortized Cost) needs to be reported as footnotes to the balance sheet and hence, has no impact on accounting. On the contrary, complex / unconventional asset products like those meant for trading/ sale are required to be categorized as FVOCI / FVTPL. These assets are required to undergo accounting treatment for their fair value difference i.e. the difference between their book value and fair value.
    Transition Process

    Fair value, again being a new feature, will need to be computed afresh by CBS. In line with bank policy, CBS would need to capture market rates and cash flows required for fair value computation. The frequency and computation date of this process may also be decided as per bank policy. It would be prudent if Fair Value is computed only after transition (not during / before transition) to avert unnecessary balance sheet impacts.

    Firstly, banks would need to define their policy on the definition of ‘market rate’. It can be taken as equivalent / correlated to some benchmark rate, bank’s prime lending rate or any rate at which similar products are offered to new customers, etc. Further, banks need to decide which type of cash flows they would like to use for fair value computation – contracted or expected, for various products. Apart from this, set-ups for fair value accounting need to be meticulously configured to ensure depiction of assets at their correct fair value in line with IFRS9.
    Staff Accounts Fair Valuation (IAS19)
    The concept of fair valuation already existed as part of the erstwhile IAS19 for employee benefits assessment. IAS19 is also being adopted by some nations along with IFRS9 to ensure uniformity in their fair valuation processes. As per this regulation, staff loans / deposits granted to bank employees at concessional / preferential rates are required to be fair valued at their market rate so as to bring forth clearly the interest cost borne by the bank. This cost is then required to be amortized over account tenor unitarily and interest be booked on market rate on fair value. Transition to IFRS9 (along with IAS19) would require banks to fair value their existing subsidized staff loans / deposits from the date of transition onwards, and also amortize the interest cost thus computed. It would be challenging for banks to carry out these processes for their existing accounts along with the complex accounting as required.

  4. Fee/ cost and EIR

    The Regulation
    EIR (Effective Interest Rate) is one of the major pillars of IFRS. EIR is the real interest rate earned by the bank as it accounts in for interest and fees charged from the customer and costs paid for processing and servicing an account by the Bank. IFRS insists on inclusion of upfront fees and costs for computation of EIR. It also mandates that such upfront fees and costs should not be reported inthe profit & loss Account as income/ expense at the onset but be amortized over account tenor.

    Transition for this item for existing accounts is going to be a bit of a challenge for banks’ CBS on account of the following factors. It is recommended that challenges be discussed before beginning the transition process. These challenges are: –

    • Many banks do not route fees through their main core banking systems

    • Many banks do not tag upfront fees charged to the asset account for which they have been levied

    • Since there was no mandate earlier, most banks have been taking all fees into their income account in the beginning while such loan accounts still run in CBS

    • Banks might not be using EIR method for amortizing upfront fees

    • Most banks do not capture processing cost components separately as of now

    Transition Process

    The transition process shall be different for different banks basis whether or not they have been routing fees through their core banking system or not. If not, then for further amortization, banks will need to procedurally calculate and supply the upfront fee and cost related details for respective accounts as on the date of transition to their CBS. In case fee is routed through the bank’s CBS but already taken into income on day one, a portion of such upfront fees would need to be reversed from income assuming it was being amortized since the beginning. However, retrieval of such an amount using EIR method would be too complex and cumbersome considering dynamically changing EIR value over a period of time. Hence, as one-time exception (for all practical purposes, banks may retrieve this amount of fee that is to be amortized in future, using Straight Line Method.
    For example:
    Loan disbursement date: 01-01-2010
    Upfront fee amount: USD 2400
    Loan tenor: 10 years (120 months)
    Per month amortization amount = 2400/120 = USD 20
    IFRS transition date: 01-07-2018
    Months gone by till transition date: 102 months
    Remaining tenor: 18 months
    Amortized amount = 102 * 20 = USD 2040
    Unamortized amount = 18 * 20 = USD 360
    This unamortized fee thus arrived may henceforth be amortized by EIR method in the CBS. Banks currently amortizing fees using other methods will need to change their methodology going forward.

  5. Asset Impairment

    The Regulation

    The existing Asset Classification and Provisioning process of GAAP will undergo a sea change with change in the irisk assessment model from ‘incurred loss’ model to ‘expected credit loss’ (ECL) model. With this, NPA assessment and management will no more be unilateral (solely overdue days based) as the new approach accounts for multiple qualitative and quantitative factors to arrive at a health indicator of an asset in the form of stage values – 1, 2 and 3 (1 being the best, 3 being credit-impaired). Additionally, the new set of regulations also brings along changes in income de-recognition and recognition aspects. Provisioning would now be known as ECL, which is a statistically computed value basis multiple variables.

    Transition Process
    Since impairment model itself is changing, transition of Asset classification and provisioning aspects will also change significantly in the CBS.

    • Existing processes pertaining to asset classification, impairment marking and provisioning (normal or IAS) would need to halt.

    • Core banking systems will need to scale up and work in close liaison with bank’s Risk Management system / tool or carry out required statistical computations pertaining to ECL and Stage within main CBS.

    • The stage thus arrived at for all asset accounts will need to be mapped to them, and NPA flag updation would need to be done as per stage information. Consequently, income recognition / de-recognition (suspense balance movements) processes will need to be carried out in line with the new regulation.

    • Existing asset provisions would need to be reversed (hence cancelling all existing provisions) by passing the following accounting entry:
      Dr. Asset Provision Cr.
      Cr. Transition Reserve (parking account)
      Post this, ECL accounting entry would be passed as follows:
      Dr. Transition Reserve
      Cr. ECL provisioning Cr.
      One needs to note here that the transition reserve will not be netted off completely. Since the new norms are more stringent, they would call for higher provisioning, leading to erosion of bank’s profit reserves.

    The first challenge for banks and their core banking systems would be carrying out statistical computations of ECL and stage. Since this function is already carried out by various Risk Management tools for Basel III compliance, banks may also explore integrating/ interfacing their CBS with their Risk Management system. Secondly, since IFRS does not explicitly mention processes related to income de-recognition / recognition, banks would need to devise their policy regarding this. Being a highly sensitive computation, execution of this policy would need to be handled meticulously by banks.

Local financial / banking regulators across the globe have already promulgated localized versions of IFRS applicable to respective countries. IFRS has already arrived in many countries, and will soon be adopted in the remaining ones. The industry needs to keep itself and its systems prepared to handle this regulatory ‘tsunami’. With a well-thought out policy and strategy to handle the required changes, banks can meet the challenges head-on and sail through.


  • IFRS: International Financial Reporting Standards

  • GAAP: Generally Accepted Accounting Principles

  • CBS: Core Banking System(s)

  • AC: Amortized Cost

  • FVOCI: Fair Value Through Other Comprehensive Income

  • FVTPL: Fair Value Through Profit & Loss

  • IAS: International Accounting Standards

  • MIS: Management Information System

  • EIR: Effective Interest Rate

  • SLM: Straight Line Method

  • TF: Trade Finance

  • CASA: Current Account Savings Account

  • CC/ OD: Cash Credit/ Overdraft

  • P&L: Profit & Loss

  • ECL: Expected Credit Loss

  • NPA: Non-performing Asset

Swapnil Agarwal

Senior Consultant, Finacle Product Group

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2 thoughts on “Transition to IFRS – Process and Challenges for Core Banking Systems

  • Excellent read for complete IFRS solutioning.

    • Thanks for the appreciation

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