The accounting treatment of expected credit losses by South African banks during COVID-19

Abstract

Reporting Standard 9 applies a forward-looking approach, meaning an allowance for credit losses is recognised based on expectations instead of actually incurred losses (Gubareva 2021;Stander 2021). International Financial Reporting Standard 9's expected credit loss (ECL) model is preferred as it could reduce the financial effects of procyclicality in banks (Pucci & Skaerbaek 2020), leading to greater financial stability (Novotny-Farkas 2016). Moreover, employing the ECL model and adhering to its disclosure requirements are expected to provide more decision-useful financial information, which is critical during periods of economic downturn (Novotny-Farkas 2016; Stander 2021). However, IFRS 9's possible benefits 'will crucially depend on its proper and consistent Orientation: The coronavirus disease 2019 (COVID-19) pandemic negatively affected borrowers' ability to repay debt, which is expected to influence banks' calculation of their expected credit loss (ECL) allowance. Comprehensive disclosure regarding the application of managerial judgement in calculating ECLs would produce decision-useful financial information.Research purpose: This study explored the effects of the COVID-19 pandemic on the measurement and disclosure of ECL allowances by South African listed banks.Motivation for the study: It is unknown whether decision-useful financial information regarding South African banks' ECLs was produced during the pandemic, mirroring developed countries.Research approach/design and method: Content analysis of quantitative and qualitative data from annual financial statements was employed for a sample of listed banks.Main findings: Banks employed a variety of relief measures to accommodate borrowers, but these relief measures did not automatically trigger a significant increase in credit risk. More loans were subject to lifetime ECLs, causing the ECL allowance to increase substantially during the first year of the pandemic. Forward-looking information as well as postmodel adjustments were employed to measure the ECL allowance.Practical/managerial implications: The ECL allowances of South African listed banks increased during the pandemic. Disclosure in the annual financial statements and identifying ECLs as a key audit matter provided evidence of adequate consideration of the credit risk and forward-looking information influencing ECLs by banks and their auditors. Improved disclosure regarding postmodel adjustments is required.Contribution/value-add: During the COVID-19 pandemic, decision-useful financial information regarding the calculation of banks' ECL allowances was available for South African banks, mirroring developed countries.