Challenges and innovations: What banks must do in 2019

Introduction of new standards has transformed banking landscape

An ATM keyboard stands ready at an ATM machine on June 21, 2011 in Berlin, Germany. Images used for illustrative purposes.

An ATM keyboard stands ready at an ATM machine on June 21, 2011 in Berlin, Germany. Images used for illustrative purposes.

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With muted economic growth, financial institutions would be wise to remain agile when managing regulatory challenges and technological innovations. However, this will require additional investment and capital. They may need to consider whether they have the critical mass to remain competitive.

The Basel III framework has undergone several modifications, including redefining requirements for credit, market and operational risk. Risk-weighted averages for exposures are likely to rise, which means that banks may need to increase their regulatory capital. From a governance oversight perspective, this represents a more sophisticated approach to regulation, with the need for an enhanced liquidity framework and the requirement to carry out increased stress testing.

The introduction of new standards has transformed the banking landscape, the replacement of IAS 39 with IFRS 9 being the most significant disruptor. IFRS 9 came into effect in the beginning of 2018, representing a major change in the way banks approach assessment of impairments in their loan portfolios. Higher current provisions may decrease reported profitability and increase cost of capital, as the capital adequacy ratio rises to 16 per cent by 2019 (from 10.5 per cent in 2018) with the introduction of an additional capital conservation buffer. Stricter liquidity coverage ratio and net stable funding ratio requirements will make liquidity more expensive, further affecting profitability and capital structure.

IT systems and infrastructure will likely need to be overhauled to cope with the changes, for example, systems to process default indicators pertaining to the loss-given-default calculation. Furthermore, there is an expectation that entities will carry out independent validation of models internally through their risk function or outsource the task to third parties.

Although IFRS 15 and 16 are likely to have a less material impact on the sector, they nevertheless require attention. IFRS 15 revenue from contracts with customers, which applies to an annual reporting period beginning on or after January 1, 2018, contains guidelines relevant to loyalty schemes. Time and effort must be expended to ensure compliance.

IFRS 16 leases, applicable to periods beginning after January 1, 2019, replaces IAS 17. It dictates that lessees recognise most operating leases on the balance sheet instead of recognising a periodic expense over the lease term. Banks often enter into sale-and-leaseback transactions to manage their capital or liquidity requirements, but henceforth these may no longer provide lessee banks with a source of off-balance-sheet financing. The capital adequacy ratio calculation will be affected as off-balance-sheet leases transfer to the statement of financial position. The reformed presentation of borrowers' financials will also alter expected credit loss calculations.

VAT was introduced in the UAE with effect from January 1, 2018, giving rise to several complexities. Some services provided by banks are VAT exempt, and banks have had a very short timeframe to prepare for claiming the corresponding input VAT. Bank operations will require further refinement to fully imbed the new legislation into the business, and some banks will need to rethink pricing of products.

The Financial Action Task Force mutual evaluation of the UAE will commence in 2019, necessitating independent review of anti money laundering and sanctions compliance rules. Banks, exchange houses and other financial institutions have been actively preparing for this since 2017, when they instigated a rigorous assessment of their compliance programmes.

Travelling beyond the shores of the Middle East, the European Union enforced the General Data Protection Regulation (GDPR) from May 25, 2018. Its influence was far-reaching, affecting all UAE banks with operations in Europe, as well as all European citizens resident in the UAE.

Meanwhile, the geopolitical situation in parts of the Middle East at the end of 2017 meant that banks were forced to consider the country risk limits of exposure to certain regions. Uncertainties lie further afield with Brexit, and the phasing out of Libor by 2021.

However, local banks appear to benefit from efficient adaption to global demands and technological sophistication. As an example, Emirates NBD received a high rating from UAE residents in the KPMG Global Customer Experience Excellence Report. Incorporating blockchain technology, the Abu Dhabi Global Market has rolled out eKYC (electronic Know Your Customer) procedures, progressively becoming more consumer-friendly.

In addition, the time seems ripe for mergers: several noteworthy bank amalgamations have occurred, with National Bank of Abu Dhabi and First Gulf Bank merging in 2017, and the union of Abu Dhabi Commercial Bank, Union National Bank and Al Hilal Bank currently underway.

The Central Bank of the UAE continues to issue directives on topics as wide ranging as the rotation of external auditors and the scope of services auditors may provide. A recent circular on information security indicates the necessity for banks to further refine their methods of addressing cyber risk while another details the rollout of compulsory credit checks before issuance of cheque books. The host of new regulations and directives is a welcome move, signalling that the UAE is clearly aiming to align with global best practice in terms of prudential market regulation and consumer protection.

The writer is partner and head of Audit and Financial Services at KPMG Lower Gulf Limited. Views expressed are his own and do not reflect the newspaper's policy.

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