What does IRFS9 mean for mortgages?
Piero Bassu is head of financial services and capital markets at Hometrack
New International Financial Reporting Standards (IFRS9) are due to come into force on 1st January 2018.
Now I’m realistic enough to admit that while these new regulations are fascinating to me, accounting rules are unlikely to set pulses racing among the public at large.
However, it is a big deal for financial institutions across the UK and Europe and is likely to have wider ramifications for the future shape of the mortgage market.
Among a number of changes in accounting treatments, these standards will dictate the provisions lenders need to set aside for expected losses from bad debt in their portfolios.
That is to say, that when a bank lends £1, they have to put aside reserves to cover whatever they think they might stand to lose if the investment does not go well.
IFRS9 supersedes the current, and equally snappily named, AIS39 standards.
AIS39 adopted a more reactive approach which proved to be ineffective at catching and catering for the type of accelerated bad debt increases we saw during the global financial crisis.
In contrast, the new regulation is forward looking, and demands lenders set aside reserves for pockets of the portfolio that have deteriorated performance, or ‘might deteriorate’ even though actual deterioration or arrears have not been experienced yet.
The amount of money lenders have to set aside has also increased to cover the losses that they might experience over the entire lifetime of the mortgage, rather than just in the immediate future.
All well and good, but why is IFRS9 so important in the mortgage market?
Well, put simply, it is likely to impact the very design process of mortgage products in the future.
Lenders will have to adequately price for the risk of possible increased reserves that would apply to their mortgages should these deteriorate.
This will have an obvious knock on effect when it comes to a lender’s approach to risk overall and ultimately their approach to underwriting and offering mortgages.
Obviously lenders understand their markets and don’t expect to make losses.
However, they are required by IRFS9 to be prepared for this eventuality nonetheless.
Lenders will also have to publicly disclose a lot more about the makeup of their portfolio, and manage increased volatility of provisions on an ongoing basis which will increase the pressure to make sure their portfolios are appropriately understood and adjusted for risk.
As a consequence, we are working with more and more lenders to help them understand the real value of their back book collateral and in far more granular detail than ever before.
Existing house price indices just aren’t able to offer this information and insight in the same granular way as Hometrack’s data.
It remains to be seen how all this will play out in practical terms but clearly this will be front of mind for many lenders.
It is likely to have a significant effect when it comes to the process applying for, and approving, mortgages in the future.
Watch this space…