CB wants banks’ credit loss provisioning to reflect more credible economic forecasts

• Issues revised instructions to banks asking them to use forecasts and projections published by them
• This move will effectively shun forecasts of IMF, WB and the likes 

The Central Bank of Sri Lanka (CBSL) has issued revised instructions to banks on projecting losses on their loans and other financial assets, which will effectively shun forecasts of the International Monetary Fund (IMF), the World Bank (WB) and the likes. 

In an amendment to the 2018 circular on adoption of International Financial Reporting Standards 9 (IFRS 9) on Financial Instruments, which stipulates the recognition, re-measurement/impairments and de-recognition of the financial instruments, the Central Bank asked banks to use the forecasts and projections published by them when accounting for credit provisioning. 

“Licensed banks shall use forecasts and projections published by the Central Bank of Sri Lanka (CBSL) when adjusting credit provisioning models to reflect the economic conditions and forecasts, on a consistent basis,” the amended 
circular said. 

However, the same clause in the original circular in 2018 read as, “Licensed banks shall use the forecasts and projections published by CBSL, International Monetary Fund and/or World Bank in all instances where such projections are available when adjusting credit provisioning models to reflect the economic conditions and forecasts”.

When CBSL forecasts are not available, the monetary authority asked the banks to use other, “credible alternative sources,” on a 
consistent basis. 

When accounting for impairments against loans and other financial assets, which is referred to as  ‘Expected Credit Losses’ under IFRS 9, banks measure it based on a three step process consisting of probability of default, loan loss default and economic factor adjustment, where the latter is based on accepted and credible future economic projections. 

A dourer economic projection enhances the provisions for credit losses while an improving forecast could lessen the provisions depending on the borrowers’ behaviour under probability of default and loss given under 
default methods. 

 Meanwhile, the interim financial reports of some of the major banks for September showed that they had charged hundreds of millions of additional impairments against foreign currency government bonds going by the rating downgrades and the associated gloomier forecasts for the sector and the economy at large. For instance Sampath Bank PLC said they used Fitch Ratings to determine the probability of default of foreign currency denominated government bonds and charged an additional Rs.388 million provision during the quarter ended September 30, 2020, after the Moody’s downgrading of Sri Lanka’s sovereign on September 28 by applying a 50 percent probability that Fitch Rating would also allow suit. 

Hatton National Bank PLC, which follows a similar policy to that of Sampath Bank in accounting for foreign currency denominated government bonds made an additional Rs.427 million impairment provision in the September quarter due to sovereign downgrade by Moody’s as a proactive measure in expectation of a similar move by Fitch Ratings in future.