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James Okarimia - IFRS Implementation and How the Banks should Approach IT.
1. James Okarimia - IFRS Implementation and How the Banks should
Approach it.
Though the final version of IFRS came up in 2014, the banks across the globe have
recently embarked the journey. Any new regulation requires significant effort to
revisit its existing governance, policies & processes, data and the systems and IFRS 9
is no different.
There have been multiple articles analyzing the scope and requirements covered under
IFRS in great detail. Hence, I would like to touch upon the requirements and scope of
IFRS implementation and set the context in this publication; I shall primarily share
my personal view as a risk practitioner on how the banks should approach it and be
able to meet the timeline of 2018.
Background & Scope:
IASB, in the form of its final version of IFRS published during July 2014, provides
with guidance to establish a single, uniform standard for classification and
measurement of financial assets based on the business model and cash-flow
characteristics. The primary objective is to align the bank’s risk management policies
with its accounting practice. The banks are expected to timely recognize expected
credit loss and factor that into provisions using forward-looking technique.
The scope of IFRS includes the instruments in scope for IAS 39. In addition to that, it
includes certain contracts that the banks categorize as ‘own-use’ and thereby book
2. gains through profit or loss in case of credit rating downgrade while measuring at fair
value.
A quick comparison with IAS 39 shows that the changes are primarily in the
following three aspects –
Classification and Measurement of Financial Assets and Financial Liabilities
Impairment Methodology
Hedge Accounting
Approach to IFRS Implementation
I would suggest that a regulation like IFRS will have an organization-wide impact on
governance, policies and process, data and finally on the systems. Hence, like all other
major regulatory compliance engagements, it should be treated as a transformation
program and should be broken down into three distinct phases – Assess, Design and
Implement.
IFRS requires capabilities across multiple dimensions and hence multiple work
streams are to be developed.
3. Now, let us take a deeper look at the impacted areas at which the three different tracks
should focus on. This is not a comprehensive list rather an indicative one.
Governance
Organization structure – This will require involvement of multiple teams. Especially
teams of CFO, CRO and CIO will have to align their work together. Initiative should
be driven from top and executed from bottom.
Roles & Responsibilities – CFO and CRO teams will need to take responsibility to
reconcile finance and risk data related to exposure and loss. CRO team will own the
credit risk models and scorecards. CIO team will facilitate the system implementation
around these areas.
Policies and Methodology
Policies & Procedures
Credit Policy including credit rating and collateral management & valuation
Credit risk management policies including provisioning norms and recovery policy
Liquidity risk policies especially for contractual cash flow aspect
Accounting Policies
4. Develop Business model for certain financial assets
Methodology
Impairment model methodology
Review methodology for PD models primarily to adjust from ‘Through-the-cycle’ PD
to ‘Point-in-time’ PD.
Review LGD and EAD methodology
Methodology to estimate Effective Interest Rate (EIR) to apply Time value of money
for ECL calculation
Methodology for impairment forecasting & stress testing based on adverse economic
scenarios
Models
Credit Risk Application and Behavioral Scorecards by business segments
Pricing models
Point-in-time PD model
LGD / EAD models
Behavioral life
Data
Data requirement will significantly increase both in terms of length and breadth.
While additional attributes and more granular information will be required for proper
classification of assets and credit quality, more historical data will be required to build
impairment models. Following is an indicative list of data set required for IFRS.
5. Challenges
IFRS implementation will not be too easy considering the steep timeline, wide
organizational impact, data requirements & data quality and the complexities
involved.
Timeline
The banks that embarked on the journey now or are planning to start might need to
plan extremely well to complete in time as most of the banks think that it takes at least
2.5 to 3 years to complete this.
Wide impact
Impact is extensively wide and much beyond impairment or P&L to all the factors
contributing to value of the entity such as market position, reputation etc.
Data requirements
Like any other regulation compliance, IFRS implementation is data intensive driven –
data governance and data quality will be the key.
Complexity
Lifetime expected loss impairment models will require significant change in modeling
methodology; complexity will also arise due to involvement of multiple stakeholders
and their conflicting priorities.
IFRS Changes Impacting Banks and Implementation Design
6.
7. Conclusion
IFRS implementation will definitely not be easy within the time-frame – but proper
planning and efficient execution can still make it happen. There is no time left, hence
the banks should immediately start with right earnest. Senior management will have to
drive it from top and CFO, CRO and CIO will need to align in their efforts and
initiatives.
The people driving it will require training and mandate to execute it on ground - Risk
and Finance domain expertise with experience of Data Management and Analytics
will be the skills that would make it a successful program.
A publicationby James Okarimia
Managing Partner at RM associates
Partners inEnterprise Risk Managements