PRA Letter Offers Feedback on ECL Models, IBOR Reform, and Outsourcing
PRA published a letter that provides thematic feedback to firms and auditors on topics such as the IFRS 9 expected credit loss (ECL) accounting and the global benchmark reforms. This feedback letter, from Victoria Saporta of PRA, is a result of the review of written auditor reports received in 2020 and the subsequent discussions with firms. The letter briefly sets out the main thematic findings, with Annex 1 providing detailed findings on IFRS 9 ECL accounting and Annex 2 covering findings related to the global benchmark reform, investments in technology, and third-party controls.
Each year, PRA receives a written report from auditors responding to its questions on issues of particular supervisory interest. PRA provides feedback on those reports through a number of channels, including a letter to the chief financial officers of firms. This letter highlights that significant progress has been made by all firms to enhance the controls and governance around their ECL models and data. As a result of significant efforts made by all firms, many of the high-quality practices, as described in the October 2019 letter, were already in place at the time the reports were written. However, further progress is needed. Against this background, PRA has set out the following key findings:
- Significant progress was made by firms to enhance controls around ECL models and data. Nevertheless, there were weaknesses in aspects of firms’ controls, consistent with these controls being relatively immature. In addition, weaknesses in the underlying models and data had started to emerge prior to the start of the COVID-19 pandemic, with a number of significant models either failing validation or being rated as "needs improvement." PRA expects firms to consider the adequacy of their resourcing and infrastructure to monitor model performance and react to weaknesses identified, including the adequacy of management information to enable effective oversight of models and post-core model adjustments.
- PRA noted limited progress in 2019 toward reducing reliance on post-core model adjustments by updating models, with some post-core model adjustments that appear suitable for incorporation into the model being in place longer than 12 months. PRA continues to expect firms to give due priority to the need to reduce reliance on post-core model adjustments when determining their longer term model redevelopment programs.
- Firms are encouraged to ensure that control and governance frameworks are adapted to cope with the increased reliance on the tactical processes and data. Additionally, the time taken to run the ECL processes from end-to-end leaves little room for sensitivity tools that inform effective challenge around the use of alternative economic assumptions. PRA believes that it is essential for firms to develop the capability to perform more comprehensive economic sensitivity analysis more quickly to inform governance and public disclosures.
- Firms made progress in enhancing the controls around the validation of a significant increase in credit risk (SICR) criteria. However, firms made relatively few changes to their SICR approaches in 2019. PRA believes that wider use of industry standard metrics are a good first step to benchmarking the effectiveness of different approaches across firms in recognizing SICR in a timely manner. PRA judged firms to have partially adopted the high quality practices related to SICR.
- With respect to transition from LIBOR to robust alternative reference rates, firms generally appeared to have granular transition plans and robust governance structures in place. Responses indicated an awareness and active management of both current and future risks related to conduct, legal, markets, and operations. However, there are areas where improvements could be made, particularly for firms relying on manual processes to capture and aggregate IBOR exposures; this is because such manual processes increase the risk of error and limit the ability to proactively monitor exposures.
- PRA noted instances where the risks associated with outsourcing activities to third parties were managed at the process level rather than at the third party level. Centralizing ownership and risk management would assist in ensuring the three lines of defense are appropriately engaged in managing the dependence on third parties and increasing a firm’s operational resilience. Auditors’ reports noted that firms did not always have controls reports for their material outsourcing service providers. Management continues to have a responsibility for ensuring that outsourced processes are the subject of robust and effective controls and one way of achieving this is through controls reports.
Related Link: Letter
Keywords: Europe, UK, Banking, IFRS 9, ECL, COVID-19, Credit Risk, Interest Rate Benchmark, LIBOR, IBOR, Thematic Findings, Outsourcing Arrangements, PRA
Featured Experts
Scott Dietz
Scott is a Director in the Regulatory and Accounting Solutions team responsible for providing accounting expertise across solutions, products, and services offered by Moody’s Analytics in the US. He has over 15 years of experience leading auditing, consulting and accounting policy initiatives for financial institutions.
Masha Muzyka
CECL, IFRS 9, and IFRS 17 expert; credit risk and insurance risk specialist; strategic planning and credit analytics solutions consultant
María Cañamero
Skilled market researcher; growth strategist; successful go-to-market campaign developer
Previous Article
Bundesbank Publishes Reporting Updates in August 2020Related Articles
BIS and Central Banks Experiment with GenAI to Assess Climate Risks
A recent report from the Bank for International Settlements (BIS) Innovation Hub details Project Gaia, a collaboration between the BIS Innovation Hub Eurosystem Center and certain central banks in Europe
Nearly 25% G-SIBs Commit to Adopting TNFD Nature-Related Disclosures
Nature-related risks are increasing in severity and frequency, affecting businesses, capital providers, financial systems, and economies.
Singapore to Mandate Climate Disclosures from FY2025
Singapore recently took a significant step toward turning climate ambition into action, with the introduction of mandatory climate-related disclosures for listed and large non-listed companies
SEC Finalizes Climate-Related Disclosures Rule
The U.S. Securities and Exchange Commission (SEC) has finalized the long-awaited rule that mandates climate-related disclosures for domestic and foreign publicly listed companies in the U.S.
EBA Proposes Standards Related to Standardized Credit Risk Approach
The European Banking Authority (EBA) has been taking significant steps toward implementing the Basel III framework and strengthening the regulatory framework for credit institutions in the EU
US Regulators Release Stress Test Scenarios for Banks
The U.S. regulators recently released baseline and severely adverse scenarios, along with other details, for stress testing the banks in 2024. The relevant U.S. banking regulators are the Federal Reserve Bank (FED), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).
Asian Governments Aim for Interoperability in AI Governance Frameworks
The regulatory landscape for artificial intelligence (AI), including the generative kind, is evolving rapidly, with governments and regulators aiming to address the challenges and opportunities presented by this transformative technology.
EBA Proposes Operational Risk Standards Under Final Basel III Package
The European Union (EU) has been working on the final elements of Basel III standards, with endorsement of the Banking Package and the publication of the European Banking Authority (EBA) roadmap on Basel III implementation in December 2023.
EFRAG Proposes XBRL Taxonomy and Standard for Listed SMEs Under ESRS
The European Financial Reporting Advisory Group (EFRAG), which plays a crucial role in shaping corporate reporting standards in European Union (EU), is seeking comments, until May 21, 2024, on the Exposure Draft ESRS for listed SMEs.
ECB to Expand Climate Change Work in 2024-2025
Banking regulators worldwide are increasingly focusing on addressing, monitoring, and supervising the institutions' exposure to climate and environmental risks.