PRA Provides Feedback on Expected Credit Loss Accounting Under IFRS 9

The letter noted that firms continue to evolve their ECL methodologies, enhance their models, and develop the control and governance structures surrounding the models. It is against that background that PRA set out the following main thematic findings:

• Controls around new ECL models and data—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. Auditors also commented on the adequacy of information available to management to enable the effective oversight of complex ECL models. PRA expects firms to continue to enhance their business-as-usual processes around ECL and upstream data sources.
• Model adjustments—The issue above means greater reliance is being placed on governance to identify implausible model outputs and to raise sufficient in-model adjustments, post-core model adjustments, and overlays (hereafter, together referred to as PMAs) to capture the risks and uncertainties that models missed. In 2018, progress was made in implementing model changes that will reduce the number of PMAs; however, it was noted that limited progress has been made in reducing reliance on PMAs to compensate. PRA expects firms to continue to develop and implement plans to better incorporate risks into core ECL models and to address data limitations.
• Economic scenarios—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 the country or portfolio specific shocks. PRA is keen to see the ECL methodologies evolve in the way which these methodologies consider multiple economic scenarios so that core models no longer have these gaps and have reduced reliance on material PMAs.
• Consistency—Differences (between firms and across portfolios) will exist in the approaches to the key judgement of determining whether a significant increase in credit risk (SICR) has occurred. Some progress has been made in developing metrics to monitor the sensitivity and effectiveness of different SICR approaches; moreover, there is agreement that it is important to have good metrics. However, further progress is needed to ensure that the metrics are adopted more widely and become the industry standard. PRA is talking to the major UK-headquartered banks and building societies about steps that could be taken to bring greater consistency in the application of ECL accounting under IFRS 9.

PRA has decided that it will be helpful to set out its views on practices that would contribute to a high-quality and more consistent implementation of ECL. These practices have been described in the annexes to the letter and developed using the written auditor reporting work. These practices were shared with auditors in August 2019 and, before then, a similar list was shared with the auditors in September 2018. As part of the next round of written auditor reporting questions for the 2019 year-end audit, PRA has asked for the views of autditors on the extent to which a firm has adopted these practices or has alternative processes in place to achieve the same results. PRA intends to discuss wider adoption of these practices with firms in 2020, as part of the continuing work with firms on consistent application of ECL accounting under IFRS 9.

Related Link: Letter

Keywords: Europe, UK, Banking, IFRS 9, ECL, Financial Instruments, Credit Risk, SICR, PRA