1. This report has been prepared by Alternate Research and is provided for information purposes only. Under no circumstances it is to be used or considered
as an offer to sell, or a solicitation of any offer to buy. This information has been compiled from sources we believe to be reliable, but we do not hold
ourselves responsible for its completeness or accuracy. All opinions and estimates expressed in this report constitute our present judgment only and are
subject to change without notice. This report is intended for persons having professional experience in matters relating to investments.
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Monday, May 23, 2016
International Financial Reporting Standard (IFRS) announced the new reporting
standard “Financial Instruments (IFRS 9)”, which replaces IAS 39 “Financial
Instruments Recognition and Measurement”. IFRS 9 generally applies on financial
instruments, which include, Loans and Advances, Leasing business, Investments,
Loan commitments etc. The main feature of IFRS 9 is recognition of impairment
losses on financial instruments. The implementation of IFRS 9 will commence
from Jan’18 and as an option it may be adopted early. We anticipate significant
negative impact on the bottom line earnings of the banking industry from
implementation of IFRS 9, which would require an increase in Provisioning
against Advances.
IFRS 9: Requires more scrutiny & discipline
Under current accounting standard (IAS 39) no impairment provision is
recognized at the initial recognition. IAS 39 uses “Incurred Loss Model“ for
impairment and states impairment loss only after the loss event has occurred and
its impact can be reliably measured on the future cash flows. In the light of
recently released IFRS 9, this approach leads to overstatement of assets and
profits due to delayed recognition of impairment.
The new reporting standard (IFRS 9) proposes an alternate method for
measurement of loss recognition namely, “Expected Credit Loss Model”.
According to this method, the expected losses should be recognized on the initial
recognition of asset with the amount equal to estimated 12 month expected loss
and charged to profit and loss statement. IFRS 9 contain rebuttable presumption
that if borrower failed to pay within 30 days than expected losses should be
estimated over the entire period and charge to profit and loss instead of
calculating expected on 12 month basis.
Application of new IFRS 9, will require Banks to calculate Provision on Advances
at the time of Loan origination and estimate Loan recovery loss over the life of
the Loan term by downward adjustment to the Lending rate. In this way the new
Provision made against the Loan would presumably be recorded and hidden in
Markup Return / Interest Earned (as reflected in the Profit & Loss (P&L)
Statement of Banks. Undoubtedly, application of “Expected Credit Loss Model”
will require additional provisions to be made as against the event where a loss
has already occurred. (Refer Illustration reflecting how Losses are required to be
recognized as per Expected Credit Loss Model)
Impact on the Banking Sector
The experts in the Accounting industry as well as the Banking community are still
working on identifying the best approach to identify loan losses at early stage of
the Loan life & measure and recognize the anticipated losses in the Financial
Statements. It would be highly skeptical to try and estimate an impact on the
Income Statements and bottom lines of the Banking Sector and one should wait
IFRS 9: Implication on Banking Sector
Equities Research Analyst
Muteeb Ahmad.
+9221-34326917 (Ext.)106
m.ahmad@alt-research.com

2. This report has been prepared by Alternate Research and is provided for information purposes only. Under no circumstances it is to be used or considered
as an offer to sell, or a solicitation of any offer to buy. This information has been compiled from sources we believe to be reliable, but we do not hold
ourselves responsible for its completeness or accuracy. All opinions and estimates expressed in this report constitute our present judgment only and are
subject to change without notice. This report is intended for persons having professional experience in matters relating to investments.
145-157 St John Street London,
EC1V 4PW United Kingdom
PHONE : +92 21 3432 6917-19
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for the experts from both the Accounting Industry & the Banking Industry to
agree on the modus operandi.
Nonetheless, it is clear that the resultant impact would require Banks to make
additional provisions and introduce further discipline in lending practices. We
anticipate profitability of Banks to decline due to early recognition of expected
losses. Asset values would also decline, while TEIR-1 equity will also reduce due
to charges on account of both incurred and expected losses.
Prudential Regulations Vs IFRS 9: Need more prudence from Banking Sector
Banking sector is regulated by State Bank of Pakistan (SBP), which specifies
Prudential Regulations detailing the method to calculate Provisions against
Advances. The Prudential Regulations also comply with Accounting Standards and
therefore all the Banks adequately provide for the Advances as required. The
change in Accounting Estimate is expected to create ripples since the new IFRS
introduces a stricter regime than currently in place, requiring the Banks to be
vigilant in terms of Loan losses and provisioning. We believe that SBP will, in
time, issue clarification and guidance for the Banking Sector to follow IFRS 9 or
allow discretion for a suitable period until consensus is built regarding
measurement and recognition of expected Loan losses.
Banking Sector: Identifying vulnerabilities
Pakistan’s banking sector has lately shown resilience and strength despite fewer
opportunities to increase Income. Lack of credit demand from the customers has
already resulted in lower ADRs (from a high of 89% in Oct 2008 to low of 48% in
July 2015, and currently standing roughly near 50%) as compared to historical
averages.
In addition to relatively lower exposure towards private sector credit, the Banks
have generally improved infection ratios (NPL /Advances) and coverage ratios
(Provisioning/NPL). Infection ratios have improved from 16% in 2011 to 11% at
end 2015, and Coverage ratio has also improved from 69% in 2011 to 85% at end
2015.
The Capital Adequacy Ratio (CAR) of industry for CY15 stood at 17% which is well
above the CY19 requirement of 10.25%. Improvement in infection and coverage
ratios demonstrate that the banks have employed strong risk management
systems. Also increase in Coverage ratio of industry to 85% in five years indicates
that the banks have sufficient loss reserves for expected losses.
Credit concentration of the banking sector also reflect that the banking industry
is overweight in textile, Food and Beverages, Electricity, gas and water supply,
and Agriculture, hunting, and forestry as their weight in total loan stood at 20%,

3. This report has been prepared by Alternate Research and is provided for information purposes only. Under no circumstances it is to be used or considered
as an offer to sell, or a solicitation of any offer to buy. This information has been compiled from sources we believe to be reliable, but we do not hold
ourselves responsible for its completeness or accuracy. All opinions and estimates expressed in this report constitute our present judgment only and are
subject to change without notice. This report is intended for persons having professional experience in matters relating to investments.
145-157 St John Street London,
EC1V 4PW United Kingdom
PHONE : +92 21 3432 6917-19
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EMAIL : research@alt-research.com
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Illustration
A loan of PKR 100,000 for 5yr
Cashflow of laon amount to PKR 25,000 p.a
Expected credit loss from the loan is PKR 3,000 in year 3 and PKR 7,000 in Year 4
15%, 9%, and 9% respectively. Provided that these sectors face pressure and
their overall performance declines, this would call for the Banks to provide
further in the light of Expected Credit Loss Model as per IFRS 9.
Source: ICAP , Alternate Research
Source: ICAP , Alternate Research
Year
Outstandin
g Loan
Interest
Revenue
Cashflows
(without credit
losses)
Expected
Credit
Losses
Effective
Interest
Rate
1 100,000 4,960 (25,000) 4.96%
2 79,960 3,966 (25,000) 4.96%
3 58,926 2,923 (25,000) 3,000 4.96%
4 39,849 1,976 (25,000) 7,000 4.96%
5 23,825 1,175 (25,000) 4.93%
Total 15,000 (125,000) 10,000
Year
Gross Interest
Revenue
Allowance For
Expected
Losses
Net Effect On Profit
& Loss Total Return
1 7,930 2,970 4,960 4.96%
2 6,576 2,610 3,966 4.96%
3 5,115 2,192 2,923 4.96%
4 3,539 1,563 1,976 4.96%
5 1,840 665 1,175 4.93%
Total 25,000 10,000 15,000

4. This report has been prepared by Alternate Research and is provided for information purposes only. Under no circumstances it is to be used or considered
as an offer to sell, or a solicitation of any offer to buy. This information has been compiled from sources we believe to be reliable, but we do not hold
ourselves responsible for its completeness or accuracy. All opinions and estimates expressed in this report constitute our present judgment only and are
subject to change without notice. This report is intended for persons having professional experience in matters relating to investments.
145-157 St John Street London,
EC1V 4PW United Kingdom
PHONE : +92 21 3432 6917-19
WEBSITE : www.alt-research.com
EMAIL : research@alt-research.com
Visit our Bloomberg page ARPL < go >
Industry
2011 2012 2013 2014 2015
Earnings PKR BN 112 118 112 163 199
ADR 59% 55% 52% 52% 50%
Infection Ratio 16% 15% 13% 12% 11%
Coverage Ratio 69% 72% 77% 80% 85%
Cost/income 51% 54% 57% 53% 48%
ROA 2% 1% 1% 2% 2%
ROE 15% 14% 12% 16% 16%
CAR 15% 16% 15% 17% 17%
Infection Ratio
2011 2012 2013 2014 2015
HBL 11% 11% 13% 11% 11%
ABL 8% 7% 7% 7% 6%
MCB 11% 10% 9% 7% 6%
NBP 15% 13% 16% 17% 18%
UBL 14% 14% 12% 11% 9%
Industry 16% 15% 13% 12% 11%
Coverage Ratio
2011 2012 2013 2014 2015
HBL 85% 82% 89% 89% 92%
ABL 87% 86% 95% 86% 88%
MCB 84% 89% 86% 86% 91%
NBP 76% 82% 80% 84% 89%
UBL 80% 80% 87% 85% 89%
Industry 69% 72% 77% 80% 85%
Source: SBP, Alternate Research
Source: Company Accounts, Alternate Research
Source: Company Accounts, Alternate Research