Companies must now expense the losses they expect to make as soon as their expectations change.
This column was first published in Business Day.
Bank profitability has predictably been hit hard by the Covid-19 crisis. Profits have slumped between 43% (Standard Bank) and 82% (Absa) in the first half of the year.
The issue is how to judge this in context. Sure, profits have slumped, but the banks remained profitable and their financial strength has not been compromised. Nevertheless, I do wonder if this has been the worst performance in modern financial history.
It looks worse than during the financial crisis. In 2009, Standard Bank’s headline earnings fell 17%, Nedbank’s 30%, FirstRand’s 30%, and Absa’s 24%. But accounting rules have changed since, making it difficult to tell.
Impairments, the amounts banks must set aside for bad debts, were made according to IAS 39 (International Accounting Standards) then, whereas now they are made according to IFRS 9 (International Financial Reporting Standards). The detail of accounting standards can be mind-numbingly dull, but the differences make comparing financials between the two crises tricky. IAS 39 was based on an “incurred loss” model, but IFRS 9 is based on “expected loss” — bankers must expense the losses they expect to make, rather than the losses they have actually made, as soon as their expectations change.
You can imagine how this affects the figures banks are reporting. Even though the banks are reporting on the financial results to end-June, they have incurred huge costs for bad debt. Typically, a loan only counts as defaulted after a client has missed three months’ payments. With the crisis only sparking in March, the numbers of defaulting clients had thus not materially increased by the end of the financial period. But the banks are seeing what’s coming and ratcheting up impairments to pay for it.