IFRS 9 is entering the 2021 EBA benchmarking exercise

Ryan Davis, Associate Partner and Oksana Sisterhenn, Manager at Avantage Reply Luxembourg Photo : Avantage Reply Luxembourg

Ryan Davis, Associate Partner and Oksana Sisterhenn, Manager at Avantage Reply Luxembourg Photo : Avantage Reply Luxembourg

The benchmarking exercise is a key supervisory tool to monitor and enhance the quality of the internal models. The EBA 2021 benchmark exercise is aiming to take on a new hurdle by demystifying market approaches implemented to calculate expected credit loss under the IFRS 9 requirements. 

Internal approaches used for the calculation of own funds requirements for credit and market risks are subject to annual assessment by the competent authorities (Art. 78 CRD IV). The EBA supports the competent authorities with this task by performing an annual benchmark exercise assessing the quality of internal approaches used to calculated risk-weighted exposures (RWA). The EBA benchmarking exercise does not assess the risk appetite of the financial institutions, but rather tries to understand the quality of parameters and methodology choices.

In this context, the EBA published an updated Implementing Technical Standards (ITS) on benchmarking of internal models in May of this year. Compared to the previous ITS, the most significant change comes from the integration of the IFRS 9 templates into the scope of the 2021 benchmarking exercise. No major changes were introduced for the credit risk IRB and the market risk templates besides the following:

-        Credit risk IRB templates:

                 o   Minor changes in Annex 1, in order to collect counterparties treated under the standardised approach for the IFRS 9 templates;

                 o   Removal of the temporary exemption from the RWA reporting under the standardised approach.

-        Market risk templates:

                o   Minor changes in Annexes 6 and 7;

                o   Clarification of treatment of the FX risk in the portfolio.

1.     IFRS 9 monitoring process

Since the introduction of the IFRS 9 in January 2018, the supervisory activities were focused on ensuring the high-quality implementation of these standards. Such behavior is being determined by the fact that the outcome of the expected credit loss (ECL) has a direct impact on the calculation of the own funds and regulatory ratios. In this context, the EBA published the IFRS 9 roadmap setting out the plan to monitor different aspects around its implementation. Incorporation of the IFRS 9 templates in the 2021 EBA benchmark exercise represents an important step in the EBA ongoing quantitative monitoring activities plan.

2.     The new templates

The focus of the newly introduced IFRS 9 templates is aiming to provide reliable information in order to explain the potential sources of the variability in the ECL resulting from the implementation of the new accounting standards (IFRS 9). In other words, the collection of the quantitative data on the IFRS 9 parameters should enhance the understanding of different methodologies, models, inputs and scenarios leading to the variability of the ECL results. During the 2021 benchmarking exercise, the analysis will be focused on the probability of default (PD) parameter:

a. The analysis of the variability of the PD parameter estimated over a default horizon of 12 months;

b. Variability of the macroeconomic forecasts and the interaction between the lifetime PD curve and the macroeconomic scenarios used for determining the ECL:

                  o   Institutions are required to report the variability of the macroeconomic forecast of only one macroeconomic variable GDP;

                  o   Institutions are required to submit the PD curve under baseline and the PD curve for each of the macroeconomic scenarios;

c. Variability of practices in the assessment of significant increases in credit risk (SICR):

                 o   SICR is being assessed from a combination of qualitative triggers (3 triggers) and quantitative triggers (4 triggers);

                 o   The data must be submitted at the facility level.

The IFRS 9 templates will collect data on the low-default portfolios (LDP) only. The initial focus on LDP should provide insights into the IFRS 9 parameters for the exposures assumed to have common features across institutions.

3.     Challenges ahead

The EBA sees the supervisory benchmarking exercise as one of the main tools of prudential supervision for the future. In this role, the EBA sets ambitious targets for each of its benchmarking exercises to understand and monitor the current IRB approaches and to identify the best practices for the potential future regulatory requirements.

The updated ITS provides sufficient understanding that the future benchmarking exercise will include other relevant IFRS 9 parameters like loss-given default and outstanding amount, which will increase the complexity of the benchmarking exercise reporting requirements.

Institutions should take the EBA benchmarking exercise as an opportunity to (a) strengthen their internal risk management processes incl. model estimation & monitoring, decision-making process, (b) enhance their IT processes to ensure integration of these ITS with other reporting requirements, and (c) develop control framework to ensure the sufficient quality of the submitted data.

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