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Financial Planning
and Stress Testing
Incorporating IFRS 9
July 2018
Contents
Page
Introduction 1
Contacts 7
• Now that the implementation date for IFRS 9 has • Understanding the forecasts: The profile of
passed, incorporating this new accounting standard forecasted provisions is expected to change with IFRS 9
into Financial Planning and Stress Testing remains having a front loading effect. Through detailed impact
a key challenge. assessments, sensitivity analysis, and enhanced
documentation, banks should focus on understanding
• Some of the pinch points and focus areas include
the drivers of change including the key parameters,
multiple economic scenarios and forecasting stage
assumptions, and judgements driving the estimates.
migration.
• Review, challenge, and governance: IFRS 9
• Simple approaches to tackle these challenges have
introduces additional challenges in estimation and
started to emerge, however, some firms are now
modelling and therefore banks should demonstrate
moving towards more refined capabilities.
an appropriate level of review and challenge. Model
• This paper discusses some of the key challenges with adjustments and overlays should also be considered,
IFRS 9 for Financial Planning and Stress Testing and particularly if the simplicity of initial forecasting
presents some solutions to overcome these obstacles. solutions results in uncertainty.
• Monitoring and MI: Bespoke monitoring and MI
tools should be used to maintain a detailed
Understanding the challenges understanding of provision forecasts, including:
1. Multiple economic scenarios - How forecasts they have been arrived at and
how they are evolving over time.
- How should IFRS 9 economic scenarios and
scenario weights evolve over the forecasting - The appropriateness of key modelling
horizon? components and assumptions, triggering
recalibrations when required.
2. Exposure evolution
- Transparency on model assumptions and
- How should new business, run-off, and refinance limitations, to facilitate an appropriate level
assumptions evolve over the forecasting horizon? of review and challenge.
- How will exposure assumptions impact the • ICAAP submissions: Firms are preparing their
forecasting of stage migration? ICAAP documents where IFRS 9, Financial Planning,
3. Forecasting stage migration and Stress Testing will come together. These should
highlight how the forecasts have been arrived at, and
- How should forecasted exposure migrate through how the capabilities could be refined and improved over
the IFRS 9 stages under each scenario over the time.
forecasting horizon?
- How should the IFRS 9 staging criteria be applied Key benefits
when forecasting significant increase in credit risk
(SICR)? • Increased understanding of portfolio sensitivities and
how provisions would evolve under various scenarios.
4. Forecasting/Execution
• More granular and improved understanding
- How should multiple economic scenarios, of portfolio risk profiles, loss contributions,
exposure evolution, and stage migration come and profitability.
together to forecast the IFRS 9 provisions?
• Increased confidence in the capital assessment used to
- How should the execution engine be used to steer management actions and Financial Planning
understand the sensitivities and impacts of key within the business.
assumptions and approaches adopted?
• Improved accuracy of capital assessments and
• When answering these questions, a key challenge is to resulting capital buffer requirements.
ensure that the IFRS 9 solution for Financial Planning
• An improved forward looking toolkit that can allow for
and Stress Testing is consistent with the solution for
better risk management.
estimating reporting date provisions.
• Future proofing for regulatory requirements, which,
are expected to become more sophisticated.
0 1 2
Forecasting horizon
2 Exposure evolution
How should new business, run-off, and refinance
Live portfolio New Business Y1 assumptions evolve over the forecasting horizon?
New Business Y2 New Business Y3
New Business Y4
Total Exposure
New Business Y5 These assumptions should vary under each
scenario and consider the firm’s risk-appetite as
well as how industry competition and market
Exposure
4 Forecasting/Execution
Stage 1 Stage 2
Stage 3 Total Provision How should multiple economic scenarios,
exposure evolution, and stage migration come
Forecasted IFRS 9 provision
Forecasting horizon
Under the new accounting regime, IFRS 9 provision calculations as at a reporting date should incorporate the impact of
multiple economic scenarios. For Financial Planning and Stress Testing, these requirements and complexities are
amplified over the forecasting horizon.
The majority of industry has adopted a ‘perfect foresight’ approach for initial implementation of forecasting models that
incorporate IFRS 9. However, firms are moving towards more sophisticated and complete approaches to overcome the
limitations of using this simplification.
Single ‘perfect foresight’ variable path • Applies a single variable path with an implied scenario
weight of 100%.
• Does not fully capture the intention of multiple
GDP growth
Further considerations:
• A hybrid of the above approaches may be adopted. For example;
a) ‘perfect foresight’ can be used up until each reporting point for determining the IFRS 9 staging; and
b) ‘re-forecasting’ can be used from that reporting point onwards for calculating the scenario-weighted
Expected Credit Losses (ECL).
• Economic plausibility, reasonability, and coherence of scenarios and model outputs will be a key focus area, as re-
forecasting scenarios will be significantly dependent on statistical techniques.
For Financial Planning and Stress Testing, banks are required to estimate how exposures migrate through the IFRS 9
stages over the forecasting horizon. Migrations should be based on IFRS 9 staging criteria that are consistent with
reporting date calculation, and the impact of different scenarios on these migrations should also be captured.
The following approaches calculate the probability of being in each stage at each reporting point over the forecasting
horizon, and differ depending on sophistication of modelling techniques and SICR criteria.
Further considerations:
• Capturing the expected impact of macroeconomic scenarios on stage 2 transitions due to qualitative criteria remains a
key challenge. Many banks are therefore measuring the expected impact on stage 2 transitions due to quantitative
criteria, supplemented with supporting analysis that assess the reasonableness of this approach.
• Data available for developing a stage migration solution is limited to recent experience, and so supporting analysis is
required to show that these solutions hold under stress should this option be adopted.
As discussed in this paper, there are number of crucial aspects to forecasting IFRS 9 provisions. These include
methodological design decisions as well as assumptions and judgements underpinning the IFRS 9 framework. These
can all have an impact on forecasted provisions and resulting capital assessments, emphasizing the importance of
understanding and implementing a robust IFRS 9 forecasting capability.
Firms should develop a comprehensive understanding of how provisions evolve over the forecasting
horizon; analysing the front loading effect of IFRS 9, sensitivities to key assumptions, and how provisions differ
from IAS 39 methodology.
An enhanced provision forecasting toolkit should also be used to measure the profitability and resilience of
portfolios under the various scenarios considered. This can help Senior Management understand the key drivers of
retained earnings and available capital, resulting in better informed management actions and strategic decisions.
Implications on Risk-Appetite
Provisions for loan losses are expected to be front loaded, thus impacting capital ratios earlier under a stress.
Firms should seek to understand this timing affect on its Risk Appetite framework and identify exposures that drive
available capital estimations, as these may be considered too risky to grow as compared to previous assessments.
Future proofing
The regulatory requirements for forecasting IFRS 9 provisions are expected to become more sophisticated over time.
Firms should aim to develop a complete solution ahead of these changes, accelerating the benefits that they bring,
and reducing the burden of future redevelopments.
Raf Hussain
Partner
David Wong
Partner
Susie Thomas
Director
Mark Randall
Director
Giustin Leonidou
Manager
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