Quantifying the sources of volatility in the IFRS 9 impairments

Abstract

The International Financial Reporting Standards (IFRS) 9 accounting standard gives rise to impairments that are sensitive to the economic cycle. Rules around stage migration and the incorporation of forward-looking information lead to volatility in the impairments that is not always straightforward to explain. Impairment volatility and procyclicality are interlinked with the earnings quality of a bank. Research has shown that earnings volatility generally has a negative impact on firm value and share price and is considered a proxy for business risk. The impact of impairment volatility on earnings quality, together with the more detailed IFRS disclosure requirements, highlight the importance of banks being able to quantify, explain and manage the impairment volatility. This study explores the complex relationships between the different risk components that lead to impairment volatility. A Taylor series expansion is a useful tool to allocate changes in impairments to the different risk components. Finally, strategies to manage impairment volatility are explored.