Featured Product

    ESRB Paper Examines Procyclicality in Loan Provisioning Under IFRS 9

    May 02, 2019

    ESRB published a working paper that studies the cyclicality in significant increase in credit risk using the mortgage modeling under IFRS 9. Banks must make forward-looking provisions for loan losses under new international accounting standards introduced in 2018. Using detailed loan-level data on the Irish mortgage market, the paper presents a framework for assigning mortgage loans into the three stages defined under the recent IFRS 9 accounting standards.

    Assignment of loans into these stages will be central to provision calculations and stress testing exercises from 2018 on, but data limitations will prevail for some time, particularly for credit risk at origination. The delineation of performing loans into Stage 1 and Stage 2 is new and important for loan provisions, with the latter group being distinguished from the former on grounds of significant build-ups in risk since loan origination. In Europe, banks will assign performing exposures to a new “Stage 2” category with a higher provisioning penalty, if they have experienced a significant increase in credit risk. The authors use a loan-level credit risk model and Irish residential mortgage panel data to assign performing loans into the appropriate stage.

    Using this technique, the authors characterize approximately 30% of the performing Irish mortgage portfolio at end-2015 as Stage 2. They then calculate backward-looking, static estimations of Stage 2 mortgages between 2008 and 2015. This exercise suggests that loan-stage assignment can be highly procyclical. The share of Stage 2 among performing mortgages rises during the economic downturn to peak in 2013, after which large transitions are assigned from Stage 2 into lower-risk performing loans, as the economy improves. The analysis of the end-2015 data shows that Stage 2 exposures could have comprised roughly 30% of performing exposures in the Irish mortgage market.

    The study contributes to the debate on provisioning procyclicality by showing that the share of loans that would have been classified in the high-provision Stage 2 group rises from 5% to 50% of all mortgages during 2008-2012, in line with a sharp contraction in the Irish economy. Such a pattern suggests that a regime such as IFRS 9, relative to its IAS 39 predecessor, may lead to a smoother pattern for provisions during a downturn, while simultaneously having a higher correlation between provisions and the state of the economy. Further research is warranted on the exact mechanisms that underpin the procyclicality, or otherwise, of bank provisioning under various regimes as well as the general equilibrium effects on loan origination and bank capital.

     

    Related Link: Working Paper (PDF)

     

    Keywords: Europe, EU, Banking, Accounting, IFRS 9, Procyclicality, Credit Risk, Loan Loss Provisioning, Stress Testing, Mortgage Default, Loan Origination, ESRB

    Featured Experts
    Related Articles
    News

    BoE Consults on Approach to Setting MREL, Publishes Bail-In Guidance

    The Bank of England (BoE) published a consultation paper on approach to setting minimum requirement for own funds and eligible liabilities (MREL), an operational guide on executing bail-in, and a statement from the Deputy Governor Dave Ramsden.

    July 22, 2021 WebPage Regulatory News
    News

    EBA Seeks Views on Proportionality Assessment Methodology

    The European Banking Authority (EBA) is seeking preliminary input on standardization of the proportionality assessment methodology for credit institutions and investment firms.

    July 22, 2021 WebPage Regulatory News
    News

    US Agencies Propose Changes to Call Reports and Instructions

    Certain regulatory authorities in the US are extending period for completion of the review of certain residential mortgage provisions and for publication of notice disclosing the determination of this review until December 20, 2021.

    July 22, 2021 WebPage Regulatory News
    News

    PRA Finalizes Rulebook Definition of Higher Paid Material Risk-Taker

    The Prudential Regulation Authority (PRA) published the policy statement PS18/21, which introduces an amendment in the definition of "higher paid material risk taker" in the Remuneration Part of the PRA Rulebook.

    July 21, 2021 WebPage Regulatory News
    News

    EBA Examines Asset Encumbrance in Banking Sector

    The European Banking Authority (EBA) published its annual report on asset encumbrance in banking sector.

    July 21, 2021 WebPage Regulatory News
    News

    EBA Publishes Methodological Guide to Mystery Shopping

    The European Banking Authority (EBA) published a methodological guide to mystery shopping.

    July 21, 2021 WebPage Regulatory News
    News

    APRA Issues Update on Capital Reform Policy Settings for Banks

    The Australian Prudential Regulation Authority (APRA) released a letter to authorized deposit-taking institutions to provide an update on key policy settings for the capital framework reforms, which will come into effect from January 01, 2023.

    July 21, 2021 WebPage Regulatory News
    News

    CPMI-IOSCO Assess Continuity Planning of Market Infrastructures

    The Committee on Payments and Market Infrastructures (CPMI) and the International Organization of Securities Commissions (IOSCO) published a report that assesses the business continuity planning activities of financial market infrastructures or FMIs.

    July 21, 2021 WebPage Regulatory News
    News

    BoE Announces Changes to Validation Rules for Form BTL

    The Bank of England (BoE) published questions and answers (Q&A) on OSCA to BEEDS migration for statistical reporting as well a presentation from the project overview session held with statistical reporters.

    July 20, 2021 WebPage Regulatory News
    News

    BCBS Proposes Changes to Process for Reviewing G-SIB Methodology

    The Basel Committee on Banking Supervision (BCBS) is consulting on a technical amendment to the Basel Framework to reflect a new process reviewing the global systemically important bank (G-SIB) assessment methodology.

    July 20, 2021 WebPage Regulatory News
    RESULTS 1 - 10 OF 7281