Lenders, as well as other firms that are significant holders of issued debt or other assets with elements of credit risk, face a period of considerably increased risk of defaults and non-payment. This will manifest in an increase in the base level of IFRS 9 impairment allowances (Expected Credit Losses) in stages 1 and 2. Increased flow into stage 3 (default), a traditional measure of credit risk, will likely follow in subsequent years, but the financial impact on balance sheets will start earlier, reflecting the forward-looking nature of the accounting standards.
All this will happen as banks are in the midst of bringing back into their capital positions the deferred impairments arising from the COVID-related International Financial Reporting Standards (IFRS) 9 transitional arrangements. Firms will need to ensure that they can demonstrate to supervisors and auditors that the underlying parameters in their IFRS 9 models accurately reflect the risk in their balance sheets.
Credit concerns exist in many sectors. In commercial real estate, the International Monetary Fund (IMF) recently warned about tightening financial conditions5, while a recent Deloitte global survey of the sector indicated that sustained high inflation is a significant concern for Chief Finance Officers (CFOs), and that as many as a third of respondents are looking at cost-cutting measures in 2023, up from just 6% the previous year6. The hospitality and tourism sectors face lower demand for their offerings in an environment where discretionary spending is constrained. Deloitte’s October 2022 CFO survey shows UK CFOs in all sectors expressing concern over the cost of borrowing, with a resultant increase in expectations that cost control – including reducing hiring expectations – will be a key business priority in 2023 and possibly beyond. As commercial and corporate customers face reduced revenues and profits, the likelihood of lay-offs is considerable, and increased unemployment will exacerbate the pressures on retail customers already discussed.