IFRS 9

Challenges and proposed methodology

 Table of Contents

01 02 03
Impact and How to prepare to Proposed
challenges adopt IFRS9 Methodology

I. Influence of I. Setting up I. Loss rate

IFRS 9 on overall roadmap approach
financial II. Analyzing II. Use of
institutions impact and parameters
II. Challenges to preparing under Basel II
financial resources for
III. Impairment
institutions implementation
automatic tools
III. Relationship III. Building
between IFRS 9 models,
and risk validation and
practices implementation

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 SECTION 1
Impact and challenges
I. Impact of IFRS 9 (1/2)

 Reinforce relationship  Change in

between Finance - measurement method
Risk and make provision

Processes and policies

 Profit  Allocate revenue, under IFRS leads to
expense and credit change in guidance
 Capital

Management
product pricing handbook, accounting
Adequacy
Finance

policies under IFRS

Ratio and  Recruit, admin and
other financial coordinate  Essentiality to build
ratios departments economic forecast
process
 Budgeting  Manage risk and
process internal control:  System upgrade
complete supporting in leads to changes in
financial statement storage and data
preparation under collection process
IFRS 9

According to Research result of impact of IFRS 9 by European Banking Authority in 2016:

• Provision increases average from 18%-30%
• Capital Ratio decrease average of 59 bps (0.59%)

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I. Impact of IFRS 9 (2/2)

Non-compliance

Do not adopt IFRS 9 for Confusion for users of IFRS financial

IFRS report statement, especial foreign partners

Qualify audit opinion

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II. Challenges of IFRS 9

01 02 03

High cost Investor reaction Unavailable data base,

 Investment in IT system  Impact of IFRS 9 on Human Resources and
 Planning and profit system to implement IFRS 9
implementing expense  Big impact of objective  System does not support
 Recruitment and Human factors and technical  Inexperienced Human Resource
Resource maintenance evaluation on provision to apply IFRS 9, lack of forecast
expense data expert, Risk Management expert
 Training expense  Depend on macro  Lack of historical data to run the
economic forecasts model
 v.v

The need to develop IFRS 9 application roadmap and prepare detailed preparation and
implementation plan

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III. Relationship between IFRS 9 and Risk management
practices (1/2)

IFRS 9 towards risk management practice under Basel

Risk management practice

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III. Relationship between IFRS 9 and Risk management
practices (2/2)

Use of Basel II Parameters

Basel credit models are also PD, LGD are impacted by

macro economic factors:
adjusted to shorten the distance
 GDP
between estimated default rate and  Unemployment rate
actual default rate. Accordingly, it is  House prices
necessary to identify Central Effective maturity  CPI
Tendency or average PD during (M)  Cross-industries
long-term for each category  v.v.

Probability of default Exposure at default

short-term (1 year) – PD Credit EAD Bank exposure to
counterparty score risk default

Rating/ LGD
Substitution
Credit
Conversion
Loss Given Default Factor
Obligor score Substitution
– loss in the event of Collateral
of Guarantor if guarantor Reduction
default (LGD)

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 SECTION 2
How to prepare for adoption of
IFRS 9
I. Proposed overall roadmap

Gap analysis, impact

assessment and resources Modelling and validation IFRS 9 implementation
preparation
measurement
Classification

- For institutions which

and

have book keeping and

prepare financial
statements under IFRS:
Impairment

From 1 January 2018

Preparation phase – It is necessary to have detailed plan for each
- For institutions which
step of work
convert the financial
statements from Local
GAAP to IFRS:
accounting
Hedge

depending on frequency
of conversion

System upgrade and improvement

Training

Coordination amongst different departments and divisions, especially between Finance and Risk

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II. Gap and Impact analysis and resource preparation

Impact analysis Resource preparation

 Analyze the difference

between IAS 39 and IFRS 9
 Gap analysis (data, people, 1  Expert
system, process) recruitment (if
necessary)
 Identify available resources
(including models under  Personnel training
Basel II for credit risk,  Task allocation
market risk, stress testing, and coordination
etc.) and their ready for use  Budgeting for IFRS
under IFRS 9 9 preparation and
 Analyze advantages and implementation.
disadvantages of the current 2
classification models against  System upgrade
requirements of IFRS 9  Updates of
 Perform impact assessment processes and
on finance, people, system procedures
and operating model as well
as business processes

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III. Modelling and validation

Classification

measurement
 Comprehensive review of the current portfolio for classification purpose
 Constructing methodologies and controls
and
1

 Upgrading accounting system for classification and measurement purpose

 Designing templates/tools for business model test and SPPI test

 Analyzing the current Basel models that credit institutions are applying and the readiness of these
models for use under IFRS 9
 Constructing loss rate model in case no Basel models have been built up yet
 Building, assessing and testing methodologies
Impairment

 Testing models, selecting amongst different options and making decision

2

 Collecting historical data for model development

 Designing, implementing and testing systems and data
 Forecasting economic factors impacting ECL and probabilities of different situations
 Validating models based on practical data
 Developing IT system to improve the storage of all relevant information
accounting

 Identifying risk management strategies relevant to risk management objectives

Hedge
3

 Reviewing the portfolio and identifying contracts/transactions which are for hedging purpose
 Designing and applying testing models

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 SECTION 4
Proposed methodology
 Proposed Methodology

1 2
Gap analysis Methodology

 Methodology for  Methodology for

Classification of Impairment
financial instruments

 Using  Using risk

loss rate parameters
approach (PD, LGD,
EAD) under
Basel II

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Methodology

1. Classification
2. Impairment

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 Classification of financial instruments

1: Development of checklist for SPPI test and BM test

• Develop list of questionnaires for SPPI test

• Develop list of questionnaires for Business model tests
• Formulae the results using excel

2: Manual for classification and measurement of

financial instruments

• Propose controls for risks of misclassification

• Draft the manual for classification and measurement of financial instruments

3: EY classification automated tools

• Customize EY automated loans to Client’s financial instruments’ characteristics

• Validation of tools

4: Support in classifying the existing portfolio of

financial instruments

• Perform the SPPI test for the existing portfolio of financial instruments
• Perform Business model test for the existing portfolio of financial instruments

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Methodology

1. Classification
2. Impairment

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 Methodology for Impairment

Use loss rate approach Use risk parameters under Basel II

12-month PD under
Historical loss ratio
Basel II
Historical PD
PD data

Past
performance Ready for use
LGD Forward LGD Basel II under IFRS 9
Former looking model
portfolio

EAD Previous EAD

customers

Through the
12-month ECL Point-in-time PD
Life-time ECL
cycle PD

NOW FUTURE
Basel II
implementation
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Loss rate approach

► IFRS 9 allows the use of Loss rate is calculated in a similar way compared with collective
the loss rate approach in assessment under IAS 39
estimating ECL:
► An entity develops loss
rate statistics on the Step 1 Stratifying loan portfolio by products
basis of amount written
off over the life of the
financial asset rather
than using separate
probability of default and Using migration models, calculating migration rate
Step 2 and historical loss rate
loss given default
statistics
► These historical loss
trends must be adjusted
for current conditions Building correlation formulae between loss rate and
and expectations about Step 3
macro economic factors
the future
Using Basel II parameters (1/2)

Differences of risk management practice between Basel II and IFRS 9

The table below describes basic differences of the estimation of risk parameters (PD, LGD, EAD) in the calculation formula of ECL
(under IFRS 9) and EL (under Basel II).
Credit losses under IFRS 9 can be greater or smaller than Basel II’s (estimation of LGD, EAD under IFRS 9 might be lower under
IFRS9 but life-time PD is probably higher than through-the-cycle PD).

IFRS 9 Basel II
PD Measurement 12-month (Stage 1) 12-month Through-the-
period Life-time (Stage 2 and 3) cycle PD might
have a stable
Cycle Point-in-time Economic cycle trend
sensitiveness (around 5 years)
Consider macro economic factors
and forward - looking information
estimated at each reporting period Life-time PDs of
loans in different
LGD Measurement Neutral risk estimation Downturn estimate periods might
EAD increase or
Consider macroeconomic factors decrease based
and forward - looking information on changes in
estimation of
Do not assess debt collection fee macroeconomic
Assess debt collection fee
factors and
forecast
information

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Using Basel II parameters (2/2)

Conversion steps

 Analyzing the current credit risk models

 Identifying macro economic factors impacting ECL (GDP, unemployment rate,

etc.) and relationship with PD, LGD

 Calculating life-time PD, LGD, EAD for each customer/product

 Based on the above parameters, calculate ECL at reporting date for every
customer/product in accordance with IFRS 9 (considering prepayment rate and
discount rate)
IFRS 9 EY Impairment Tools

Impairment Analyzer and Loan Impairment Calculator

EY Impairment Analyzer
► High-level impact tool to understand the
financial impact of IFRS 9 on provisions
► Standardized MS Access based platform
developed specifically for IFRS 9 calculations
► Data mapping tool allows flexible input data
structure
► Built-in customizable reporting

Loan Impairment Calculator (LIC)

► Production solution calculating provisions on the
account level
► Standardized solution consisting of SQL data layer
and web-based interface
► Fully customizable reporting set up during
implementation
► Implemented in ~20 European banks

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THANK YOU!