Thailand was originally scheduled to adopt the International Financial Reporting Standard (IFRS) 9 from 1 January 2019, one year after the International Accounting Standard Board (IASB)’s effective date. However, in July 2018, the Federation of Accounting Professions decided to postpone the mandatory effective date by a further one year, to 2020. This postponement allows Thai banks the opportunity to become better prepared for IFRS 9.

Modelling challenges

IFRS 9 is a complex topic which has shifted the thinking within financial institutions (FIs) from being prescriptive to being principle-based in their approaches. Risk and finance departments within FIs are debating on challenges relating to Impairment calculation, such as: Should the model be built from scratch or based on existing internal ratings-based (IRB) models? What’s the basis for determining risk stage transition? What are the key considerations when performing quantitative validation of expected credit loss ECL models? What to do in the absence of data? What are the guidelines around usage of macroeconomic models?

The above questions need to be thought through and discussed thoroughly across the functions.

The nature of modelling for ECL itself presents challenges. As it is a forward-looking approach to credit quality, FIs will need to estimate ECL over the entire life of financial instruments – they will need to monitor exposures continually, considering future variations in inflation, GDP, interest rates, employment, housing price indices, and a plethora of other macroeconomic factors. The ECL model also cannot be a one-size-fits-all approach – it must be capable of being applied to different asset classes.

The critical role of model validation

The issue is further compounded by other challenges such as the availability and quality of historical data, availability of technical expertise and the level of sophistication of management reporting systems. There is also little regulatory guidance on modelling as it relates to IFRS 9. The onus is on FIs to convince regulators and auditors on the soundness of their modelling methodologies and assumptions. Many banks around the world have invested to become IRB-compliant and therefore have a head start. Most Thai banks however, are in early stages of their journey to be IRB-compliant.

Compared to the previous IAS 39 standard therefore, models developed for IFRS 9 have to meet a higher standard – they have to be far more sophisticated and holistic. This only magnifies the importance of undertaking comprehensive and independent validation of IFRS9 impairment calculations, models and assumptions. Models should be validated to ensure that they are fit-for-purpose, taking into account the range of global and local requirements.

The opportunities

Banks have good reason to view IFRS 9 as opportunity.

For example, IFRS 9 is an opportunity to achieve alignment between the risk and accounting functions, which in many FIs continue to operate as silos. Such an alignment would benefit in many ways – in terms of economies of scales, a standard way of measuring credit risk across the FI, integrating data sources, unified modelling and processes, and streamlined reporting.

IFRS 9 is also a departure from the approach to impairment prescribed by the IAS 39 accounting standard, which requires models to factor in only past events and current conditions in measuring credit losses, which contributes to a delayed recognition of credit losses. The ECL model not only helps FIs to arrive at a more accurate provisioning required, it also requires them to monitor assets closely, as well as to keep an eye on the evolving risk profiles of customers and in view of this, to generate data on them at a more granular level.

A few welcome side-effects of the above are: sounder analytics and segmentation of customers, according to profit potential; sounder business projections and transparency, when reporting to shareholders and stakeholders; mitigation of over- or under-provisioning in banks’ portfolios, allowing banks to remain competitive while complying with the regulatory requirements.

IFRS9 brings with it many challenges for banks, with a potential to negatively impact profitability if dealt with as merely a compliance checkbox exercise. This will have a knock-on effect on consumers and businesses who may see their mortgage rates go up and access to loans go down. Ultimately, the purpose of IFRS 9 is to bolster the health and resilience of the banking industry. Thus, the key lies in striking the right balance between ensuring regulatory compliance and building a sustainable revenue proposition. This is what will differentiate the market leaders from the rest.

Critical success factors

On this road to IFRS 9 compliance, we would recommend FIs to prioritise several key points, and when choosing a partner in this journey, ensure that they are able to provide support in the following respects:

• A bespoke approach: The FI and the partner must be committed to a customised approach related to the development and validation of models.
• High quality analytical support: The provision of bespoke modelling methodologies depending on data availability, portfolio type and existing Basel models (if any).
• Economic modelling: The provision of advanced macroeconomic models, along with flexible scenario-design capabilities.
• A strategic roadmap: A structured and well-thought through plan to attaining IFRS 9 compliance by January 1, 2020 or earlier.

Experian’s experience and expertise

Experian currently works with a number of Thai banks on their IFRS 9 journey. Our approach is to undertake a comprehensive and independent validation of IFRS9 impairment calculations, models and assumptions. Our analytics service embedded with strong business understanding helps us to avoid any over or under provisioning for banks’ portfolios arising from model shortcomings, thus allowing banks to remain competitive while complying with regulatory requirements.

We have deep expertise in credit risk modelling and econometrics, strongly supported by our focused global center for methodological R&D and subject matter expertise relating to IFRS 9. We have acquired an understanding of regulatory expectations gained through multiple Basel models, loss forecasting models and scorecards delivered each year.

IFRS 9 models can also be deployed on Experian’s PowerCurve platform, which turns data into insights, facilitating decision making and strategy formulation.

Dev Dhiman
Managing Director, Southeast Asia & Emerging Markets