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

    EU Amends CRD4 and CRD5 as Part of Capital Markets Recovery Package

    EU published Directive 2021/338, which amends the Markets in Financial Instruments Directive (MiFID) II and the Capital Requirements Directives (CRD 4 and 5) to facilitate recovery from the COVID-19 crisis.

    February 26, 2021 WebPage Regulatory News
    News

    EU Committee Recommends Systemic Risk Buffer of 4.5% in Norway

    The Standing Committee of the European Free Trade Association (EFTA) recommended that a systemic risk buffer level of 4.5% for domestic exposures can be considered appropriate for addressing the identified systemic risks to the stability of the financial system in Norway.

    February 25, 2021 WebPage Regulatory News
    News

    PRA Clarifies Approach to Onshoring of Credit Risk Rules for UK Banks

    In a recent statement, PRA clarified its approach to the application of certain EU regulatory technical standards and EBA guidelines on standardized and internal ratings-based approaches to credit risk, following the end of the Brexit transition.

    February 25, 2021 WebPage Regulatory News
    News

    FSB Sets Out Work Priorities for 2021

    In a recently published letter addressed to the G20 finance ministers and central bank governors, the FSB Chair Randal K. Quarles has set out the key FSB priorities for 2021.

    February 25, 2021 WebPage Regulatory News
    News

    EU Publishes Corrigendum to Revised Capital Requirements Regulation

    EU published, in the Official Journal of the European Union, a corrigendum to the revised Capital Requirements Regulation (CRR2 or Regulation 2019/876).

    February 25, 2021 WebPage Regulatory News
    News

    ESAs Issue Statement on Application of Sustainability Disclosures Rule

    ESAs published a joint supervisory statement on the effective and consistent application and on national supervision of the regulation on sustainability-related disclosures in the financial services sector (SFDR).

    February 25, 2021 WebPage Regulatory News
    News

    EC Consults on Crisis Management and Deposit Insurance Frameworks

    EC published a public consultation on the review of crisis management and deposit insurance frameworks in EU.

    February 25, 2021 WebPage Regulatory News
    News

    HKMA Enhances Loan Guarantee Scheme to Alleviate Pressure on SMEs

    HKMA announced that enhancements will be made to the Special 100% Loan Guarantee of the SME Financing Guarantee Scheme (SFGS) and the application period will be extended to December 31, 2021.

    February 24, 2021 WebPage Regulatory News
    News

    EBA Proposes Standards for Supervisory Cooperation Under IFD

    EBA launched consultations on the regulatory and implementing technical standards on cooperation and information exchange between competent authorities involved in prudential supervision of investment firms.

    February 24, 2021 WebPage Regulatory News
    News

    BoE Addresses Banks in Scope of First Resolvability Assessment

    BoE issued a letter to the CEOs of eight major UK banks that are in scope of the first Resolvability Assessment Framework (RAF) reporting and disclosure cycle.

    February 24, 2021 WebPage Regulatory News
    RESULTS 1 - 10 OF 6629