In this final article of our 3-part series on IFRS 16, we took a look at the new lease standard from a broader perspective to see what its implications for capital and operations of financial institutions would be when it comes into effect in replacement of “IAS 17” next year.
IFRS 16 will be changing the lease accounting guidelines of lessees, who will need to include most leases on their balance sheets to enhance transparency.
In light of these changes, IFRS 16 will have a significant impact on the financial sector. Banks will be required to enter property lease commitments on the branches they occupy. This will have serious implications on the lessee-banks’ balance sheets.
Impact on capital and operations
IFRS 16 will have significant implications on the financial statements, operations and capital requirements of financial institutions. Monitoring controls and reporting requirements, will significantly increase total assets and liabilities for some banks.
Due to the complexity for geographically dispersed bank branches that do not have lease commitments, there is a period of preparation that will have to take place. Banks will need to ensure that they have the processes, systems and controls in place necessary to comply with the new leasing standard.
And, while the economic benefits and risks of leasing will not change, the new lease accounting model will alter the key financial metrics and key performance indicators (KPIs) of banks. A PwC research study found that the average company will experience a 13% increase in Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). Profitability metrics, such as earnings per share, return on equity, and operating cash flow, will all be impacted with the oncoming standard.
Until now, financial institutions have been entering into long-term operating lease commitments that haven’t been recognized on their balance sheets. When the IFRS 16 comes into effect, these off-balance sheet leases will result in an increase in the total assets and liabilities of the banks and their branches.
Under this standard, sale-and-leaseback transactions won’t receive the kind of support for financing since these transactions must be reported on the lessee balance sheets.
Banks are also anticipating that IFRS 16 will affect the way they do business with their customers, since the impact of the new standard may extend to the banks’ borrowers, who may have significant operating lease commitments.
The new lease standards will work to improve financial reporting about leasing transactions of financial institutions by requiring them to recognize assets and liabilities for leases, with certain exceptions, on their balance sheets.
The new mandate will result in significant changes for financial institutions who will need to change to their processes and workflows, and will need stronger internal controls to monitor all leasing activity throughout the lifecycle of leases.