The global financial crisis of 2008 exposed a critical flaw in global accounting: the “too little, too late” problem of recognizing credit losses. When the crisis hit, banks were slow to provision for expected loan defaults because the prevailing standard, IAS 39 (Financial Instruments: Recognition and Measurement), only allowed them to recognize a loss after an actual event of impairment had occurred.
To address this systemic risk, the International Accounting Standards Board (IASB) developed IFRS 9 (Financial Instruments), which came into effect globally on January 1, 2018. For Kenya’s vibrant and competitive financial sector, this transition—mandated and guided by the Central Bank of Kenya (CBK)—represented one of the most significant changes in financial reporting in decades.
1. The Core Difference: Impairment Models
The most profound change is the shift in how financial institutions account for potential losses on loans and other financial assets.
| Feature | IAS 39 (The Old Standard) | IFRS 9 (The New Standard) |
| Impairment Model | Incurred Loss (ICL) | Expected Credit Loss (ECL) |
| Loss Recognition | Losses were recognized only after an objective loss event (e.g., a payment default, bankruptcy). | Losses are recognized immediately based on expected future losses over the life of the asset. |
| Perspective | Backward-looking (relying on historical data/events). | Forward-looking (incorporates current conditions and future macroeconomic forecasts). |
| Impact on Crises | Delayed and sudden recognition of large losses, exacerbating financial instability. | Promotes earlier, smoother provisioning, enhancing financial resilience. |
Kenyan Context: The CBK required all licensed commercial banks, mortgage finance companies, and microfinance banks to adopt the ECL model, aiming to strengthen capital adequacy and reduce systemic risk in the economy.
2. Classification and Measurement
IFRS 9 introduced a simpler, principles-based approach to classifying financial assets, replacing the complex, rules-based categories of IAS 39.
| Aspect | IAS 39 (The Old Standard) | IFRS 9 (The New Standard) |
| Categories | Four categories (Held-to-maturity, Loans & Receivables, Available-for-Sale, FVTPL). | Three primary categories (Amortized Cost, Fair Value through OCI, Fair Value through P&L). |
| Classification Test | Based mainly on management’s intent and specific rules. | Based on two objective tests: 1) The Business Model Test (how assets are managed) and 2) The SPPI Test (Solely Payments of Principal and Interest). |
Kenyan Context: This change requires Kenyan financial institutions to clearly define and document their business model for managing financial assets (e.g., a portfolio of consumer loans held to collect contractual cash flows would be measured at Amortized Cost).
3. The Implementation Journey in Kenya: Challenges and Capital Relief
The forward-looking ECL model of IFRS 9 requires banks to provision earlier and often at a higher amount than under IAS 39. This had a direct and potentially negative impact on two key metrics: Profitability and Regulatory Capital.
A. Data and Modeling Challenges
Kenyan institutions, especially smaller ones like SACCOs and Microfinance Banks, faced significant challenges:
- Data Granularity: The ECL model requires highly granular historical data (Probability of Default, Loss Given Default, Exposure at Default). Many lacked the sophisticated IT infrastructure to capture and process this.
- Forecasting: Models must incorporate reasonable and supportable forward-looking information related to Kenya’s economy (e.g., inflation rates, GDP forecasts, interest rate movements set by the CBK).
B. CBK’s Capital Relief and Transition Period
Recognizing the potential for a sudden shock to capital levels, the CBK provided a crucial transitional measure:
- Five-Year Add-Back: Starting in January 2018, the CBK allowed licensed institutions to add back the incremental (additional) IFRS 9 provisions on performing loans to their retained earnings for the purpose of calculating their regulatory Core and Total Capital ratios.
- Purpose: This temporary measure, which concluded after five years, was designed to allow banks to gradually absorb the higher provisions without violating mandatory capital adequacy requirements.
Conclusion:
The move from IAS 39 to IFRS 9 in Kenya was not merely an accounting exercise; it was a fundamental regulatory shift towards a more proactive and risk-aware financial system.
While the change demanded significant investment in talent, systems, and modeling expertise, the long-term benefit for the Kenyan financial sector is clear: greater transparency, more prudent loan loss provisioning, and enhanced resilience against future economic shocks, ultimately safeguarding depositors and promoting financial stability in East Africa.
Implementing IFRS 9 doesn’t have to be complex or costly. At FineIT, we specialize in IFRS 9 ECL modeling, data gap solutions, system implementation, and regulatory reporting for Kenyan banks, microfinance institutions, and SACCOs.
Whether you’re building models from scratch or strengthening existing frameworks, our team of quantitative experts and financial engineers is ready to support you every step of the way.