Private and Confidential

IFRS9 Implications & Challenges

GARP – Istanbul Chapter

Presenter:
Sandip Mukherjee, Cofounder - Aptivaa
23rd March 2016
Agenda

 About Us
 IFRS-9 Guidelines: Key Requirements
 IFRS-9 Vs. IRB Approach
 Basel ECL Guidelines
 Aptivaa’s IFRS-9 Approach
 Q&A

2
About Aptivaa
 About Us

Brief Background | Journey so far

- Proven credentials having worked with over 100 financial institutions

- Global Presence with offices in UAE, USA, UK & India

Consulting
- Emerging India first runner up in CNBC-TV18 in 2008 Services

- Cutting Edge IP in Risk Management, Analytics & Reporting

Analytics
- 100+ institutions as clients across over 20 countries

- Thought Leadership in the Risk Management industry Data and

Technology

2005 - Aptivaa 2008 – CNBC Award 2016 – Global

Launched as a for Emerging India presence with offices
focused Risk in UAE, USA, UK &
Consulting firm India

4
 Breadth of Our Offerings

Credit Risk Market Risk Operational Risk ALM, Liquidity Risk Basel, IFRS 9,
Management Management Management and FTP COSO compliance

Functional (Banking Specific) support to

other areas as well as aspects such as
Consulting governance, policies, regulatory
Development of compliance, documentation etc.
Functional & Technical
Architecture
Intermediate Credit Risk Models (PD,
Banking LGD, EAD, IFRS 9)
Data Governance and solutions for
Management small to mid-
sized Banks Market Risk (Risk and
Pricing) and CVA
Models
Risk Aggregation and Core Risk
Reporting (BCBS 239) Technology
Implementation Management Analytics ICAAP and Stress
Services Offerings Testing
Support
Tactical Solution
Development and
Economic Capital, EVA,
Implementation
RAROC
Use of statistical
End-to-end System analysis to
Implementation (Third arrive at
Party Solutions) Operational Risk AMA
solutions

Resource
Augmentation

5
Introduction to IFRS 9
 IFRS 9 Accounting Standards: An Introduction

 IFRS-9 standards have been developed by IASB & FASB over the years after considering inputs from Banks, FIs,
groups such G20, Financial Crisis Advisory Group

Mandatory Compliance Deadline January 1, 2018 > Need to Start Now

Principle Based Approach instead of Rule Based

Inclusion of new accounting rules & Introduction of New

Expected Credit Loss Model

Support Groups

IFRS-9 is mandated for

institutions from annual
periods on or after
January 1, 2018. The new standards
Considering the have replaced rule- IFRS 9 introduces new
complexity of changes in based standards of IAS classification category
systems & processes & 39 and aims to closely (FVOCI) for debt Various support groups
data requirement, Banks align with risk instruments. Also, being created to handle
would require minimum management, as such incurred loss model of interpretational
of 2 years for management will apply IAS 39 is replaced with challenges:
implementation & Dry considerable judgment forward looking Expected  ITG Meetings
run to ensure the in implementing the credit loss model.  Local Supervisor
readiness for 2018 changes to IFRS Impairment losses will be  Local banking
recognized sooner than associations
under IAS 39  CFO/CRO/Audit
Groups
IFRS: International Financial Reporting Standard FASB: Financial Accounting Standards Board
IASB: International Accounting Standards Board IAS: International Accounting Standards

7
 IFRS9 Implications / Challenges

IFRS9 has the following major implications on the Banking, Insurance & Financial Services industry:

Comparability & Consistency

Financial Impact
• Principal based guidelines
• Provisions expected to significantly
• Interpretational Issues
increase on transition date
• Practical Expedients / Simplifications
• Increased Volatility
• Judgemental Overlay
• Increased Procyclicality
• Disclosures are key to standardization
• Decline in shareholder’s equity &
& quality
Capital Ratios

Firm Challenges Industry Challenges

• No market standard • Heavy burden for smaller
• Data Unavailability Classification institutions
& Measurement
• Forward Looking view • Regulatory Uncertainty
• Significant increase in • High or Low Quality Adoption
credit risk Impairment • Dual provisioning framework in
• Closer integration some countries
between risk & finance Hedge
Accounting

Business Strategy
Skillset Building • Business Models and plan
• Core teams & senior redesign
management skills to be • Product restructuring
upgraded • Pricing strategy
• Regulator, Auditor, rating • Capital & Dividend plans
agencies, investor & analyst
also need training

8
 IFRS9 Categories: Developments over IAS39

IAS39
Principles

• Introduction of new measurement category ‘Fair Value

through other comprehensive Income’ (FVOCI)
• Classification of instruments are now based on-
Classification & a) Entity’s Business Model
IFRS9 Principles Measurement b) Contractual Cash flow characteristics
• New requirements for the accounting of changes in the fair
value of an entity’s own debt where the FVO has been
applied (own credit issue)

9
 Overview of Classification & Measurement

IFRS 9

The classification is based on both the entity’s business model for managing the financial
assets and the contractual cash flow characteristics of the financial asset

(i) Business Model Assessment

Based on the overall business, not instrument-by- (ii) Contractual Cash Flow Assessment
instrument
Entity’s business model determines whether financial assets Based on an instrument-by-instrument basis
are –
Financial assets with cash flows that are solely payments of
a. Held to collect contractual cash flows
principal and interest (SPPI) on the principal amount
b. Both held to collect contractual cash flows and selling of
outstanding.
financial assets
c. FVTPL (not falling under the above two categories)

Business Model SPPI Criterion

Yes Amortized Cost

Financial Assets

1
Hold Assets to collect cash Yes Are the assets contractual cash flows
flows solely payments of principal & interest
No Yes
FVOCI
2
Collecting cash flows & Yes Are the assets contractual cash flows
selling financial assets solely payments of principal & interest
No
Neither 1 nor 2
FVTPL

10
 Illustrative classification under IFRS 9 vis-a-vis IAS 39

 Diagram below represents illustrative classification under IAS 39 vis-à-vis IFRS 9 and is based on assumption that the
intent of management will not significantly change under IFRS 9
 Classification is subject to satisfaction of SPPI test and business model of the bank

Held to Maturity
Hold to collect Amortized cost
 Dated securities - Sovereign business model Generally, these securities
Intention
and corporate bonds would satisfies SPPI test

Loans and advances

 Plain vanilla loans except for
loans held for sale

Available for sale

 Equities and preferred stock Hold to collect and Fair value through other
 Discounted securities, sale business model comprehensive income
Intention (FVOCI)
corporate bonds,

Fair value through profit or

loss
 Equity securities FVPL business
FVPL
 Dated bonds model Intention
 Securitized instruments
 Loans held for sale

11
 IFRS9 Categories: Developments over IAS39

• Introduction of new measurement category ‘Fair Value

through other comprehensive Income’ (FVOCI)
• Classification of instruments are now based on-
IAS39
Principles
a) Entity’s Business Model
Classification & b) Contractual Cash flow characteristics
Measurement • New requirements for the accounting of changes in the fair
value of an entity’s own debt where the FVO has been
applied (own credit issue)

• Introduction of new hedge accounting model

IFRS9 Principles • Closer alignment of accounting for hedge instruments with

risk management
Hedge Accounting
• Broader scope for accommodating entity’s risk management
strategy and the rationale for hedging on the financial
statements

12
 IFRS9 Categories: Developments over IAS39

• Introduction of new measurement category ‘Fair Value

through other comprehensive Income’ (FVOCI)
• Classification of instruments are now based on-
IAS39
Principles
a) Entity’s Business Model
Classification & b) Contractual Cash flow characteristics
Measurement • New requirements for the accounting of changes in the fair
value of an entity’s own debt where the FVO has been
applied (own credit issue)

• Introduction of new hedge accounting model

IFRS9 Principles • Closer alignment of accounting for hedge instruments with
risk management
Hedge Accounting
• Broader scope for accommodating entity’s risk management
strategy and the rationale for hedging on the financial
statements

• IFRS 9 replaces IAS 39 Incurred Loss Model with new

Expected Credit Loss (ECL) model
• ECL model is applicable for instruments classified under
Amortized Cost and FVOCI category (only for Debt)
Impairment
• Need to incorporate forward-looking information (macro
economic factors) for estimation of expected credit loss
• 3-Stage model for portfolio quality assessment & ECL
estimation

13
 IFRS9 ECL Framework

General / Collective Provisions Specific Provisions

IAS 39 – Incurred Loss Model
Credit losses are recognized only on the Performing Watch-List Non-Performing
occurrence of a loss event Assets Assets Assets

IFRS 9 – forward-looking expected credit

loss model
Recognizes 12-month loss allowance at initial Stage 1 Stage 2 Stage 3*
recognition, and lifetime loss allowance on
significant increase in credit risk

Significant increase in credit risk Object evidence

(PD) since initial recognition of impairment

12-month Expected
Impairment Lifetime Expected Credit Loss
Credit Loss

Net Carrying
Recognition of Interest Gross Carrying Amount
Amount

* Stage 3 impairment calculation is status quo with IAS 39 methodology 14

 Credit Deterioration Triggers

Identification of indicators for increase in credit risk i.e. movement of an asset to Stage 2 from Stage 1, for calculation of
lifetime expected loss is a key challenge:

Significant difference in rates or terms of newly

1 Change in internal credit spread (or risk premium) 2 issued similar contracts

Actual or expected change in External Credit

3 CDS spread, equity or debt price 4 Rating

Actual or expected change in Internal Credit Existing or forecast adverse changes in business,
5 Rating or Behavioral Score 6 financial or economic conditions

Actual or expected significant change in operating Significant increase in credit risk on other financial
7 results of borrower 8 instruments of the same borrower

Regulatory, economic, or technological

9 10 Collateral value
environment of the borrower

Reductions in financial support from parent entity

11 Quality of guarantee 12 or credit enhancement quality

Expected change in loan documentation (covenant Significant changes in the expected performance
13 waiver, collateral top-up, payment holiday etc.) 14 and behavior of borrower or group

Changes in bank’s credit management approach

15 16 30-dpd rebuttable presumption
(or appetite) in relation to the financial instrument

15
 Expected Credit Loss (ECL)

 ECL is an unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes
 The purpose of estimating expected credit losses is neither to estimate a worst-case scenario nor to estimate the best-case
scenario. Instead, it shall always reflect the possibility that a credit loss occurs and the possibility that no credit loss occurs
even if the most likely outcome is no credit loss.
 When making the assessment, an entity shall use the change in the risk of a default occurring over the expected life of the
financial instrument instead of the change in the amount of expected credit losses.
 Practical Expedients:
 An entity may assume that the credit risk on a financial instrument has not increased significantly since initial
recognition if the financial instrument is determined to have low credit risk at the reporting date

 Consider the reasonable and supportable information that is available without undue cost or effort at the reporting date
about past events, current conditions and forecasts of future economic conditions.

 30 days past due rebuttable presumption

 Use of provision matrix to estimate ECL for trade receivables

 The discount rate to be used for the measurement of expected credit losses i.e. Effective Interest Rate (EIR) should be
the same as the rate used for the purpose of interest revenue recognition
 Lifetime Expected Credit Loss or Significant increase in Credit Risk is a relative concept (from risk pricing perspective)

16
 Lifetime ECL

 PD Term Structure is key to estimation of Lifetime Expected Credit Loss (LECL)

 An illustration is given below for LECL computation:

EL1 = PD1 * LGD1 * EAD1

EL2 = (1- PD1) * PD2 * LGD2 * EAD2

PD1

PD2
ELN = (1- PD1) * (1- PD2)...* (1- PDN-1)* PDN * LGDN * EADN
Homogeneous pool of 1-PD1
customers
Discounting EL1 1-PD2
at T=0
PDN

Discounting EL2
Where EIR = Effective at T=0 1-PDN
Interest Rate

Discounting ELN
at T=0

T=0 Maturity


 EAD and LGD estimates could also vary based on different time points. For an example, an amortized loan (mortgage
loan) as on 2015, will have lower LGD in 2017 compared to 2016 as the LTV will decrease (for simplicity assuming a
single factor (LTV) based LGD model). EAD will also be lower in 2017 as compared to 2016.

17
 Differences between Basel - IRB and IFRS 9

Theme Basel – IRB Approach IFRS 9

Regulators allow exclusion of certain IFRS 9 doesn’t permit partial use of

Model Coverage portfolio outside the treatment of IRB impairment models on the
(Partial Use) and can be under standardized instruments which are identified under
approach the scope

Multi-period estimation is necessary

Estimates of PD represent probability
(for stage -1, 2 & 3)
PD Calibration of default over a 12 month horizon
IFRS 9 requires Point in Time
PDs are calculated on the basis of
estimates (PiT), with inclusion of
historical long-run average (TTC)
macro-economic factors

IFRS 9 doesn’t provides complete

Under FIRB supervisory LGDs are
Loss Given Default clarity on LGD calculations.
permitted to use, however under
(LGD) Regulatory LGDs can be the basis or
AIRB Downturn LGD estimation is
Long run avg. /point in time LGDs
required
estimates.

IFRS 9 framework expected credit

Excepted Credit Loss The Basel framework expected credit
loss model looks more point-in-time
(ECL) loss model looks through-the-cycle
logic to arrive at Lifetime Expected
logic
Credit Loss

18
 Concept of Defaults and Predictions

PIT PD TTC PD:

Estimates of PIT PD represent TTC PD is calculated on the basis of

probability of default over a future historical long-run average historical
horizon (typically 12 month) using default. Borrower TTC PD will not
statistical methods using recent change due to economic conditions
historical data. Probability of Default of as long run average includes
a borrower under PIT Framework will economic downturn effects.
fluctuate in line with economic cycle.

PD Term Structure
12 Month Prediction: Lifetime Prediction:
PD(%)

The PD model predicts default within Lifetime PD estimates cumulative

the next 12 months. The 12 month probability of default over the life of a
horizon prediction is generally used exposure . The prediction can be
for BASEL capital calculation or EL done either by using PIT PD or TTC
1st year 2nd year 3rd year PD framework. For IFRS 9, the
calculation.
lifetime PD should be calculated
based on PIT PD.

19
 Macroeconomic effect on PD

 According to IFRS9, the PD should be forward looking i.e. the PD should be predicted using past event, current
conditions and future outcomes.
 Relevant macroeconomic factors like GDP, stock index, oil price etc. could be used to forecast the PD Term Structure.

GDP
PD Calibration - Normal Vs Stressed Case
35.00%
Exchange Employment Normal PD
Rate Indicator 30.00%
Stressed PD
2 (Change in Default Rates)_t = 0.0119 - 2 25.00%
Macroeconomic 0.00142 * (Stock Index)_t-1 * - 0.00114 20.00%
factors
*(GDP)_t-1 - 0.000211 *(Employment 15.00%
Indicator)_t-1 - 0.000152 *(Inflation)_t-1 10.00%
Stock Index Inflation 5.00%
0.00%
Interest
1 2+ 2 2- 3+ 3 3- 4+ 4 4- 5+ 5 5- 6+ 6 6- 7+ 7 7-
Rate

Building relationship
using statistical
methodologies to
predict Z Score

1
Z Score

20
 PD Term Structure Methodologies

1
Binomial Movement Approach: PD Term Structure

PD(%)
PD in next 3 years =
Binomial movement approach assumes that the borrower will
either default or will remain in its current credit quality. This PD1 + (1- PD1) * PD1 + (1- PD1)
approach assumes no transition in credit quality. The PD Term * (1- PD1) * PD1
Structure under this approach is developed based on 1 year PD 1st 2nd 3rd
year year year
rate.

2
Credit Deterioration Approach: AAA AAA One Year average PD
AA N
Under this approach, it is assumed that in addition to default, AA

borrower also has probability of moving to other credit rating A A

grades (typically represented in the form of Transition Matrix). BBB BBB BBB
PD Term structure under this approach is developed through
transition matrix multiplication. D D

1st year 2nd year

3
BASEL Maturity adjustment Approach:
Basel III capital calculation formula (ASRF) uses a maturity 1 + 𝑀 − 2.5 ∗ 𝑏(𝑃𝐷)
adjustment formula to convert 12 month PD to Lifetime PD 𝑀𝑎𝑡𝑢𝑟𝑖𝑡𝑦 𝐴𝑑𝑗𝑢𝑠𝑡𝑚𝑒𝑛𝑡 =
1 − 1.5 ∗ (𝑏(𝑃𝐷)
based on maturity of the exposure.
Where , b(PD) = (0.11852-0.05478*log(PD))^2

4
Multi year Transition Matrix Approach
Under this approach, Banks needs to develop Transition Matrices for multiple years ( 1,2,3…). PD Term Strcuture can be
developed directly by taking PD from these multi year Transition Matrices.

21
 Impairment Methodologies
Roll Rate Models
Model Characteristics
 Segments are created based on
Delinquency or PD bands
 Determines flow of instruments or
loss across Transition Matrix
 May be augmented with vendor
data
 Relatively robust and transparent
 Predicts loss rate account
migration and recovery analysis
 Frequently used for short-term
loss forecasting
IFRS 9 prerequisites
 Longer Time Series data required
 Assumptions on pre-prepayment
patterns
 Linking roll rate rates with macro-
economic drivers to incorporate
forward looking scenarios in the
loss estimates
 Separate estimation of Lifetime
PD
 Assumptions on effective maturity
at portfolio or segment level
Limitations
 Does not consider loan specific
information
 Heavy assumptions for long term
estimations
Portfolio Suitability
 Retail Assets
Vintage Loss Models
 Losses are estimated using
multistep process
 Separates estimation of
vintage effect, economic effect
and maturation effect
 Tend to use primarily for
consumer portfolios
 Used for Long term loss
forecasting
 Longer Time Series data
required
 Assumptions on pre-
prepayment patterns
 Separate estimation of
Lifetime PD
 Does not consider loan
specific information
 Retail Assets
Provision Matrix Model
 Based on historical data and
judgment
 Done at a homogenous
segment level
 Directly predicts loss ratio or
loss amount
 Typically used for the short
term trade receivables
 Need to develop models to
incorporate macro-economic
variable for forward looking
scenarios
 Assumptions on pre-
prepayment patterns
 Separate estimation of
Lifetime PD
 Assumptions on effective
maturity at portfolio or
segment level
 Does not consider loan
specific information
 Heavy on assumptions
 Trade Receivables, Contract
assets
Expected Loss Model
 Predict default probability or
loss severity by using loan
specific characteristics and
macroeconomic inputs
 Often used to calibrate vendor
models
 Much more complex modeling
concepts
 Much more data intensive
 Use of Survival model to
predict Time to default
 Need to make the maturity
adjustment if Survival model is
not used
 Assumptions on pre-
prepayment patterns
 Assumptions on lifetime
maturity
 Heavy on data requirements
 Corporate and Retail
Discount Cash flow Method
 Individual assessment of
instruments
 Required business and
individual customer level
knowledge
 Future cash flows are
discounted by the
EIR(effective interest rate)
 Quantitative measures for
loss forecasting by
integrating macro-
economic drivers
 Assumptions on pre-
prepayment patterns
 Assumptions on lifetime
maturity
 Difficult to implement for
large number of
instruments in the banking
book
 Corporate
22
 BCBS Guidance (d350) on ECL

 Supervisory expectations regarding sound credit risk practices associated with implementing and
applying an ECL accounting framework (8 principles for banks & 3 for regulators)

 BCBS has significantly heightened supervisory expectations of the high quality, robust &
consistent application of IASB standards at internationally active and sophisticated banks.

 Stress on ‘periodical supervisory prudential review’ of the methodologies adopted by various

banks for ECL estimation.

 BCBS has not provided any exemption bucket for compliance to accounting standards, and
therefore, all the lending exposures should be considered for ECL estimation.

 BCBS has recognized that supervisors across jurisdictions may adopt a proportionate approach
with regard to the guidelines issued to banks of different scale and complexities.

 BCBS has explicated that due consideration should be given to the principle of materiality, and
should not be assessed only on the basis of the potential impact on the P&L statement at the
reporting date.

 BCBS expects that banks should have robust policies and procedures in place for validation of
models, thus maintaining its rigor stance for model governance framework, consistent with the
requirements for Basel II IRB purposes.
 Information Set: BCBS expects banks to develop systems and processes that use all reasonable and supportable information that is
relevant to the group or individual exposure, as needed to achieve a high-quality, robust and consistent implementation of the approach.
This will potentially require costly upfront investments in new systems and processes but the Committee considers that the long-term
benefit of a high-quality implementation far outweighs the associated costs, which should therefore not be considered undue.

 Low credit risk: IFRS 9 introduces an exception to the general model in that, for “low credit risk” exposures, entities have an option not to
assess whether credit risk has increased significantly since initial recognition….In the Committee’s judgment use of this exemption by
banks would reflect a low-quality implementation of the ECL model in IFRS 9.

 30dpd rule for stage 2: BCBS would view significant reliance on past-due information (such as using the more-than-30-days-past-due
rebuttable presumption as a primary indicator of transfer to LEL) as a very low-quality implementation of an ECL model.

23
Aptivaa’s Approach & Methodology
 Overview of Our Approach for IFRS 9 Compliance

1 Governance & Review of Impairment Review of Data

Impact Assessment Allied areas
Policy Overview models Architecture & Systems

• Assessment of • Assessment of Data • Assess the impact of

WS 1: Gap, • Credit Risk,
• Impact assessment
existing credit risk & availability for provisions on bank on core areas of
Impact & Accounting, Model stress testing models Impairment capital ICAAP
Design Management, and
• Develop Concept calculations • Assess the need of
Hedging policies and • Impact on pricing
Notes for key ECL • Changes required in required skill-set,
procedures areas (RAROC)
2 existing IT systems staffing and trainings

Process & Policy Development of

Data & Systems Allied Areas
WS 2: Development Impairment Models
Specification and • Documentation of rules • Validation & recalibration • Data & system gap • Updating policies
Implementation for Asset Classification of existing models resolution strategy related to credit risk
• Updating accounting, strategy, ICAAP report
• Identification of credit • Data Flow architecture
provisioning, credit risk, deterioration triggers • Functional DataMart for • Updated reporting
hedging policy and
• Lifetime ECL estimation disclosures & reporting frameworks
disclosures
3

Organizational
Parallel Run Training
WS 3: Parallel run Structure Review
& Business
Transition Change Management Audit & Regulator
Program Feedback

25
 Impairment Models: Portfolio Coverage & Model Inventory

High level review of portfolio coverage & IFRS9 suitability of credit risk models (PD, LGD & EAD), credit monitoring and stress
testing models need to be performed

Portfolio Coverage & Model Inventory

 Basel allows partial use of IRB i.e. exclusion of certain portfolio outside the treatment of IRB Approach due to lack of
internal models and the way out is to continue using standardized approach for them. However IFRS9 doesn’t permit
partial use of impairment models on the instruments which are identified under the scope and a bank is required to
produce risk estimates for all portfolios whether on individual or collective basis.

 Prepare an inventory of all existing models relevant to IFRS9 ECL framework such as credit rating models, credit risk
scorecards, LGD, EAD, prepayment behavioral models, credit monitoring / early warning models, and macroeconomic
stress testing models etc.
Model Coverage
Portfolio
Segment Rating / Stress Monitoring/Early
LGD EAD Prepayment
Scoring Testing Warning
Bank No No No No No No

Corporate Yes No No Yes No No

SME Yes No No Yes Yes No

Auto Loan Yes Yes No Yes No No

Home Loan Yes Yes No Yes No Yes

Credit Cards Yes Yes Yes Yes Yes No

Personal Loans Yes Yes No Yes Yes No

 All the relevant model documents, dataset and prior validation reports (if any) need to be collected for further
assessment.

26
 Impairment Models: IFRS9 Suitability Assessment

Impairment Models Suitability Assessment Criteria

 Model construct, portfolio coverage, underlying data/assumptions & documentation

Credit Risk Rating  Model Validation results or Audit comments (if any)
or Scoring Models  Rating and Calibration Philosophy (PIT / TTC / Hybrid)
 Presence of behavioral or forward looking factors (if any)

 Model construct, portfolio coverage, underlying data/assumptions & documentation

 Model Validation results or Audit comments (if any)
Loss Given Default
 Discount factor used to calculate present value of recoveries and expenses
(LGD)
 Calibration Philosophy (PIT, Average or Downturn LGD)
 Availability of external recovery/LGD data and its suitability for benchmarking

 CCF Model construct, portfolio coverage, underlying data/assumptions & documentation

Exposure at
 Model Validation results or Audit comments (if any)
Default (EAD)
 Prepayment or behavioral maturity modeling (if any)

 Indicators or criteria used for credit monitoring or early warning frameworks

 Definition of default, 30 dpd rule (cure rate data availability),
Stage Assessment
 Credit Rating process (upgrade/downgrade), behavioral scorecards (if any)
 Availability of initial rating or PDs

 Macroeconomic forecasts and availability/role of Economist (if any) at the Bank

 Stress Testing models for forward looking impact on Ratings, PD, LGD, EAD etc.
Stress Testing  Models establishing linkage between macroeconomic factors to bank specific risk factors
and their suitability for scenario generation and Lifetime PD forecasting
 Model construct, portfolio coverage, underlying data/assumptions & documentation
 Forward looking assessment (horizon, sophistication, suitability for IFRS9)

27
 IFRS9 Architecture – Go Strategic or Tactical ?

With regards to IFRS9 compliance strategic roadmap, the key decision that bothers banks is
whether the software architecture should be of a strategic integrated nature or one that is
decoupled and modular ?
We propose to follow our 4Rs framework while trying to figure out whether a strategic, integrated
solution is needed or a more tactical but modular solution:

 Readiness – How ‘ready’ are you with the expected credit loss computation methodologies? If you are not yet ready or
believe methodologies are likely to evolve over time, then a modular approach may work best.
 Reflectiveness - User access and control is as much an important criteria as is automation. During this compliance
exercise, in the initial stages, data availability for estimation of various risk components will be an issue. Banks will be
required to check the data inputs and outputs for each of the underlying models used in the ECL computation so that
validation, error resolution and judgemental overrides (based on management decision) could be performed at each level
of ECL computation. There should be an ability to deliberate and ‘reflect’ upon various intermediate outputs.
 Redundancy - Are you already struggling to maintain a plethora of solutions that seemingly do very similar tasks?
Yes, Redundancy is another major factor to be considered. Banks should look to leverage existing infrastructure like
Basel II IRB infrastructure instead of creating another parallel infrastructure for IFRS9.
 Regularity - Are you looking to (re)generate ECL computation results on a daily basis? If the answer to the question is
Yes, then indeed a fully integrated strategic solution is needed. However, in our experience, the frequency or regularity of
usage is quarterly or maybe monthly at most. In such circumstances, traditionally, tactical modular architecture based
solutions work better. Level of automation required for data feeds (Manual data upload or ETLs) should be based on
cost-benefit analysis.

Organise stakeholder workshops to discuss key issues, pros/cons of both approaches in context of existing
infrastructure and IFRS9 compliance timelines.

Develop an ideal IFRS9 Architecture along with strategy for database and level of automation required at various
levels.

28
 Illustrative Data Flow Architecture –
Multiple sources increases computational complexity
Source Systems Documentation
Input Data Feed
Core Banking/ Treasury & Models
Sources CIF/ CRM Recoveries Contracts
Trade Finance Finance Database

A B C D E F

A Management
Amortized A
Cost 2 Judgment
Business Model Credit Deterioration
B
identification Assessment Framework
1 FVOCI C
Stage
Classification
C Practical expedients Assessment
Cash flow (More than 30 days
characteristics test FVTPL past due, etc.)
F
7
Loss Calculator
Regulatory
Provisions 4 12-months
LGD EIR Lifetime PD
PiT PD 5
EAD Calculator
Stage 2 & 3 Stage 1
IAS 39 Provisions
Collateral
Information 3 Macroeconomic A
8 Adjustment Behavior
Provisioning
B
A E PiT& Lifetime PD
Prepayment
9 Macro Economic C
Reporting 6
Tool Variable Analysis Expected
Rating Models Maturity F
Calculator
Financial IFRS 9 Contractual
Reconciliation Maturity
statements Disclosures D

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Illustrative Functional Architecture & Data Model

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