Banks struggle with IFRS 9 implementation

The UK’s major banks are making progress in implementing IFRS 9 Expected Credit Loss accounting (ECL) but there remain weaknesses in aspects of firms’ controls and management information around reporting impairment allowances

The Bank of England’s Prudential Regulation Authority (PRA) has warned that more needs to be done to ensure consistency and is calling on financial institutions and their auditors to review how the implement the accounting standard.

Victoria Saporta, PRA executive director, prudential policy, has written to CFOs providing thematic feedback to banks and their auditors after a review of the written auditor reports received in 2019.

‘A pervasive issue continues to be weaknesses in aspects of firms’ controls and management information around new ECL models. Significant progress has been made in embedding end-to-end controls around economic data and forecasts, but further progress is needed,’ said Sparta.

Auditors also commented on the adequacy of information available to management to enable the effective oversight of complex ECL models. As a result, greater reliance is being placed on governance to identify implausible model outputs and to raise sufficient in-model adjustments and post-core model adjustments (PMAs) to capture the risks and uncertainties that models missed.

Saporta said: ‘We were pleased to hear that in 2018 progress was made in implementing model changes that will reduce the number of PMAs, but we also noted that limited progress has been made in reducing reliance on PMAs to compensate, for example, for low modelled provision cover for mortgages.

‘We expect firms to continue to develop and implement plans to better incorporate risks into core ECL models and to address data limitations.’

Most firms raised PMAs to attempt to compensate for gaps in how their core models consider multiple economic scenarios. These PMAs captured additional low probability, high impact scenarios related to country or portfolio specific shocks, which the PRA says banks should now try and include in their core model.

The letter also flags up concerns that there should be greater efforts to create agreed, industry-wide metrics to assess risk, with the PRA talking to the major UK-headquartered banks and building societies about steps that could be taken to bring greater consistency in the application of IFRS 9 ECL.

It stated: ‘ We know there will be differences (between firms and across portfolios) in approaches to the key judgement of determining whether a significant increase in credit risk (SICR) has occurred, but are concerned that these approaches will not all respond in the same way to changes in risk when economic conditions change.

‘We were pleased to see that some progress has been made in developing metrics to monitor the sensitivity and effectiveness of different SICR approaches, and agree that it is important to have good metrics.
‘ However, further progress is needed to ensure metrics are adopted more widely and become industry standard.’

The PRA has written to CEOs and CFOs on ECL implementation issues each year since the transition to ECL began.

Saporta’s latest letter says: ‘Whilst we recognise that progress has been made on the above issues this year with significant efforts being made by all the firms, the findings above are consistent with the findings from our review last year in 2018 and the expectations above are unchanged from my letter to you in April 2019.’

In annexes to the latest letter, the PRA has set out  its views on practices that would contribute to a high quality and more consistent implementation of ECL, which have also been shared with the banks’ auditors.
The regulator says that as part of the next round of written auditor reporting questions for the 2019 year-end audit, it asked for the auditors’ views on the extent to which each firm has adopted these practices, or has alternative processes in place that achieve the same results.

The letter concluded: ‘We would greatly appreciate firms engaging with their auditors in carrying out this work by performing their own analysis on how they have adopted the practices and by making that analysis available to their auditors as part of the year-end audit. We intend to discuss wider adoption of these practices with your firm in 2020 as part of our continuing work with firms on consistent application of IFRS 9 ECL.’

Written auditor reporting – thematic feedback from the 2018/2019 reporting period 

By Pat Sweet

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