How Is Your Bank Prepared for IFRS 9 Implementation?

Credit risk reporting in accordance with IFRS 9 is a necessity for all banks. This task appears to be more important now than Basel implementation. Basel implementation is being conducted for relatively long time. It deals with only risk management and is based on relatively simplistic models (in expected loss calculation). Realisation of these models for regulatory purposes (it is meant standardised approach) does not require significant investments in methodology, credit risk management business processes and IT-infrastructure.

On the contrary, IFRS 9 initiative was relatively recently put forward. It requires more complicated risk models. IFRS 9 is not bound by risk management only, but deals with the whole-bank management. In fact, it is meant to improve financial reporting. Therefore, key performance indicators (KPIs) will likely be measured on the basis of IFRS 9. Investors, counterparties, rating agencies will judge about the Bank looking at financial statements based on IFRS 9. This reporting will be in the core of regulation.

At a first glance, Basel compliance guarantees IFRS 9 compliance. However, this is misleading. In reality, methodology difference makes this transformation practically impossible, if the bank hopes to take it as given. Some differences are described in our previous article. In reality, IFRS 9 implementation is a separate project. The project team has to apply significant efforts to manage the project, to benefit from it, to transform the project results into resilient business processes. Only in this case Basel implementation costs provide benefits for IFRS 9.

How is bank prepared for successful IFRS 9 Implementation? What should it accomplish before the project kick-off? These questions carry keys for success of IFRS 9 project.

To simplify the project planning our company has developed questionnaire that helps to identify methodological and technological gaps, bottlenecks, project tasks where resources should be concentrated.

The first group of questions covers credit portfolio management principles. One of the corollaries from it is how the whole portfolio is split into the parts, where individual and group expected loss calculations are applied. This methodological decision should taking on the basis of statistical analysis, concentration analysis, its dynamics, and correspond to client and credit policy of the bank.

The next step is realisation of divide et impera principle. Borrowers, credit products, collaterals, etc should be segmented. Modelling approach has to be specified for every segment.

Risk calculation is based on the models. If expected losses are calculated for the groups of financial instruments, past due amounts information is more forward-looking than any other information (eg credit rating of the particular instruments). Individual-based calculations are usually built on rating systems and probability of default. Despite of implementation of these models under Basel approach, their applicability to the IFRS 9 should be investigated. For example, for compliance with IFRS 9 probability of default should depend on the cash flow moment. Point-in-time calibration is a challenge for modeller because statistical methods by definition work with a sample and therefore give through-the-cycle results.

Special attention should be paid to cash flow modelling, not only for loan amount cash flows but also to the interest cash flows and commissions (including commissions for past due). In some IT systems some data may be absent. In this case, either models should be modified or available data may be enriched through the additional modelling.

Moreover, IFRS 9 has special requirements to IT systems. They should provide information on past dues, cash flows for loans, collateral, and allow to cooperate deal information with borrowers’ credit quality assessment. The lack of data may be corrected through the models. On the other hand, the credit models should be developed basing on the real IT systems and their contents. Calculation power should take into account future growth in operations.

The necessity for constant risk calculation for the accounting and financial reporting compliant with IFRS 9 dictates to reconsider business processes for credit risk assessment. Decision making on the individual loan can be delegated to the analyst who generalises on this particular borrower. Credit files can be kept in paper form. But regular, rhythmic business process with higher requirements to the precision and formal justification of decisions taken should be organised in a different way. Analyst should be replaced by credit production line, conveyor. Need for point-in-time estimations prepared in line with regular financial reporting makes obligatory to reconsider probabilities of default. Their calibration becomes a business process instead of research project.

IFRS 9 calculations has to be accompanied with allowance forecasting and budgeting processes. Many IFRS 9 implementation projects keep this project stream out of the scope.

Planning for IFRS 9 implementation project in all its aspects is the cornerstone for success. Our questionnaire or another containing similar sections helps to systemise the solution of this task, and therefore this questionnaire lies in the core of the planning process. It allows to find bottlenecks, identify key directions for the project, to measure the gaps between existing state and the target structure of IT systems, business processes, methodologies.

To read more about methodology for IFRS 9 click here.
BSC solutions for IFRS 9 are shortly announced here.
Mathematics in the core of group expected loss calculations (Vladimir Babikov's article)
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Опубликовано 23 Feb 2017 Author Magister ludi

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