PRA Letter Offers Feedback on Implementation of ECL Approach in IFRS 9

The letter includes a summary of the thematic findings from the review of the 2017 (or 2017/2018) year-end written auditor reports. The findings on the implementation of the expected credit loss (ECL) approach in IFRS 9 have been set out in detail in the annex to the letter. Implementing ECL has involved a significant effort for firms and this effort is starting to deliver credit risk management benefits, including more granular and forward-looking credit risk assessments. However, as expected, firms are continuing to enhance their models and evolve the control and governance structures surrounding those models. In that context, the following are the key thematic findings from the 2018 PRA review on this:

• Weaknesses in aspects of firms’ controls and management information around new ECL models was a pervasive issue. PRA expects firms to continue to enhance their business-as-usual processes around ECL and the upstream data sources.
• The above issue means greater reliance is being placed on governance to identify implausible model outputs and to raise sufficient in-model adjustments and overlays to capture the risks and uncertainties that models had missed. PRA expects firms to develop and implement plans to better incorporate risks into core ECL models and to address data limitations. 
• Provision cover was higher where realistic but severe downside scenarios had been considered; the cover was lower where the high-impact, low-probability scenarios were missing from firms’ analyses and more weight had been given to base case scenarios. Some firms applied post-model overlays (or post-model adjustments, or PMAs) to attempt to compensate for gaps in their core models. PRA believes that material post-model adjustments should be incorporated in the core model.
• It is expected that there will be differences (between firms and across portfolios) in approaches in determining whether a significant increase in credit risk (SICR) has occurred. PRA is working with firms on various aspects of the consistent application of IFRS 9 ECL and it expects definitions of SICR and exposure lifetimes to be a part of this work. PRA will also look at the testing firms has done to assess the sensitivity of models to alternative SICR criteria.

Related Link: Letter

Keywords: Europe, UK, Banking, IFRS 9, ECL, Written Auditor Reporting Work, Thematic Findings, Credit Risk, SICR, PRA