Anda di halaman 1dari 21

Wider Fields: IFRS 9

credit impairment
modelling

Actuarial Insights Series


2016

Presented by Dickson Wong and Nini


Kung
Presenter Backgrounds

Dickson Actuary working in financial risk management: credit


risk, market risk, stress testing, regulatory capital,
Wong model validation
PwC Singapore (previously PwC Australia)

Nini Kung Actuary working in financial risk management:


credit risk, stress testing, IAS 39 auditing,
regulatory capital
PwC Singapore (previously PwC South Africa)

2
Agenda

Overview of IFRS 9 Whats Next


Stress Testing in Insights in
Banking Malaysia

Impairment modelling
Challenges
approaches

3
Banking for Actuaries
The Banking Industry presents a large opportunity for actuaries

Credit Risk Modelling roles Actuaries are applying their


Demand for require similar modelling skill set in different banking
and programming skills areas: Pricing, Treasury,
skill set Stress Testing

Introduction of IFRS 9 New Basel requirements are


requires a significant increase providing more technical
Regulatory in modelling skillset risk management and
Change modelling opportunities

Introduction of the Banking Focus on wider field


specialist courses as part of presentations covering
Education the Part 3 education system banking

4
The Need for Provisions

Banks issue loans A portion of Defaulted loans Banks must


to a variety of the loans will may incur a loss hold provisions
customers default to be written off for these losses

Expected Credit
LGD and EAD
Scorecard models PD models Loss
models
ECL = PDxLGDxEAD

Score credit riskiness Predict default Predict final loss Best estimate for
of customers probability amount expected losses

Requirements stipulated by Accounting Standards


IAS 39 IFRS 9
(current) (2018)

5
Overview of IFRS 9
In response to the financial crisis:
Existing IAS 39 considered too little too late
Regulators developed a new principles-based
Standards IFRS 9

IFRS 9 contains 3 parts:


P1: Classification and measurement
P2: Impairment Focus

P3: Hedge Accounting

Banks are facing challenges with P2: Impairment:


Sufficient data
Complexity Impairment calculation
Interpretation of requirements
6
IFRS 9 P2 Impairments Stages
Challenge:
Triggers

Performing
12 months expected
Significant deterioration in

N Stage 1 credit losses

Forward-looking adjustments
credit risk since initial

IFRS 9 Provision
Underperforming
recognition?

Lifetime expected
Loan

Y Stage 2 credit losses


Challenge:
Lifetime ECL
Non-performing

Lifetime expected
Credit impaired Stage 3 credit losses

Challenge:
Forward-looking

7
IFRS 9 ECL Model Components
Bucket 1 and Bucket 2
Macroeconomic Definitions
Alignment Required Model

Basel II IFRS 9 12 months Forward 12 months


Looking Forward Looking
12 Month PD 12 Month PD Adjustment
PD PD
IFRS 9 PD for all
accounts

Life-time PD term Lifetime Forward Lifetime Forward


Life-time Definition Looking
structure Looking PD
Adjustment

12 month/ 12 month /
Current balance Amortisation IFRS 9 EAD for all
EAD Lifetime FL Lifetime Forward
and limit profile accounts
Adjustment Looking EAD

Current collateral Forecast collateral


value values
IFRS 9 LGD for all
LGD accounts
12 month/ 12 month /
Current LGD Lifetime FL Lifetime Forward
Adjustment Looking LGD

8
Bucket 1 and Bucket 2
Macroeconomic Definitions
Alignment Required Model

Basel II IFRS 9 12 months Forward 12 months


Looking Forward Looking
12 Month PD 12 Month PD Adjustment
PD PD
IFRS 9 PD for all
accounts

Life-time PD Lifetime Forward Lifetime Forward


Life-time Definition Looking
structure Looking PD
Adjustment

12 month/ 12 month /
Current balance Amortisation IFRS 9 EAD for all
EAD Lifetime FL Lifetime Forward
and limit profile accounts
Adjustment Looking EAD

Current collateral Forecast collateral


value values
IFRS 9 LGD for all
LGD accounts
12 month/ 12 month /
Current LGD Lifetime FL Lifetime Forward

ECL model component - PD


Adjustment Looking LGD

Key Challenge: Lifetime PD Term Structure


Method 1: Cohort Analysis

Marginal Default Rate


Cumulative Default Rate Conditional for survival
Kaplan-Meier estimate of
Cumulative Default Rate

hazard functions to remove

Marginal Default Rate


potential biases in the data
,
, + , =
, 1
, + , = default hazard of a customer
months after observation
, = P(account defaults exactly months
after observation )

Years From Origination , = P(default does not occur within the Years From Origination
first months)

Considerations
Requires a long time series of data (loan lifetime; segmentation and a full economic cycle
Impacted by calendar based events (e.g. change in business policy)
Develop lifetime PD given Stage 2

9
Bucket 1 and Bucket 2
Macroeconomic Definitions
Alignment Required Model

Basel II IFRS 9 12 months Forward 12 months


Looking Forward Looking
12 Month PD 12 Month PD Adjustment
PD PD
IFRS 9 PD for all
accounts

Life-time PD Lifetime Forward Lifetime Forward


Life-time Definition Looking
structure Looking PD
Adjustment

12 month/ 12 month /
Current balance Amortisation IFRS 9 EAD for all
EAD Lifetime FL Lifetime Forward
and limit profile accounts
Adjustment Looking EAD

Current collateral Forecast collateral


value values
IFRS 9 LGD for all
LGD accounts
12 month/ 12 month /
Current LGD Lifetime FL Lifetime Forward

ECL model component - PD


Adjustment Looking LGD

Key Challenge: Lifetime PD Term Structure


Method 2: Regression Modelling
Relationship between historical PDs and behavioural factors
Analyse statistical significance and business intuitiveness of factors
Linear regression with logistic transform Cox regression for survival function



ln = 0 + =1 , = 0 =1
1

where
where 0 is the empirical hazard function, estimated
= = 1 and =
non-parametrically. Under this model, the probability
0
. of default at outcome period is given by:
1
= 1 .

Considerations
Consider transforms of variables to ensure stationarity
Different regression formats (linear regression with logistic transform preferred by most banks)
Term structure developed through including a month on book variable

10
Bucket 1 and Bucket 2
Macroeconomic Definitions
Alignment Required Model

Basel II IFRS 9 12 months Forward 12 months


Looking Forward Looking
12 Month PD 12 Month PD Adjustment
PD PD
IFRS 9 PD for all
accounts

Life-time PD Lifetime Forward Lifetime Forward


Life-time Definition Looking
structure Looking PD
Adjustment

12 month/ 12 month /
Current balance Amortisation IFRS 9 EAD for all
EAD Lifetime FL Lifetime Forward
and limit profile accounts
Adjustment Looking EAD

Current collateral Forecast collateral


value values
IFRS 9 LGD for all
LGD accounts
12 month/ 12 month /
Current LGD Lifetime FL Lifetime Forward

ECL model component - PD


Adjustment Looking LGD

Key Challenge: Lifetime PD Term Structure


Method 3: Transition matrices
Transition matrix Cumulative Default Rate Marginal Default Rate
60% 30%
From/
AAA BBB+ B- CCC D
to 50% 25%
AAA
AAA 87.0% 0.0% 0.0% 0.1% 0.0% 40% 20%
BBB+

BBB+ 0.0% 73.9% 0.0% 0.1% 0.1% 30% 15% B+


B-
20% 10%
B- 0.0% 0.1% 52.6% 11.4% 7.5% CCC/C
10% 5%
CCC/C 0.0% 0.1% 9.1% 43.9% 26.4%
0% 0%
Source: S&P Average One-Year Transition Rates For Global
Corporates By Rating Modifier (1981-2014) (%)

Considerations
Extrapolation assumes a memoryless process
Alternative method considered where cohort data is not available

11
Bucket 1 and Bucket 2
Macroeconomic Definitions
Alignment Required Model

Basel II IFRS 9 12 months Forward 12 months


Looking Forward Looking
12 Month PD 12 Month PD Adjustment
PD PD
IFRS 9 PD for all
accounts

Life-time PD Lifetime Forward Lifetime Forward


Life-time Definition Looking
structure Looking PD
Adjustment

12 month/ 12 month /
Current balance Amortisation IFRS 9 EAD for all
EAD Lifetime FL Lifetime Forward
and limit profile accounts
Adjustment Looking EAD

Current collateral Forecast collateral


value values
IFRS 9 LGD for all
LGD accounts
12 month/ 12 month /
Current LGD Lifetime FL Lifetime Forward

ECL model component - EAD


Adjustment Looking LGD

Key Challenge: Lifetime EAD


Amortising products
(e.g. term loans and mortgages)
Loan Repayment Pattern Estimating prepayments
Prepayment
=
Contractual repayment
Expected Out. Balance

Actual Out. Balance = + + +


=1 =1

= coefficient for macroeconomic variable


= macroeconomic variable
= coefficient for loan level characteristic
= loan level characteristic

Considerations
Loan level characteristics (product type, borrower income level, loan-to-value)
Macroeconomic economic variables (interest rates, unemployment rates, GDP, inflation)
Additional loan features such as refinancing

12
Bucket 1 and Bucket 2
Macroeconomic Definitions
Alignment Required Model

Basel II IFRS 9 12 months Forward 12 months


Looking Forward Looking
12 Month PD 12 Month PD Adjustment
PD PD
IFRS 9 PD for all
accounts

Life-time PD Lifetime Forward Lifetime Forward


Life-time Definition Looking
structure Looking PD
Adjustment

12 month/ 12 month /
Current balance Amortisation IFRS 9 EAD for all
EAD Lifetime FL Lifetime Forward
and limit profile accounts
Adjustment Looking EAD

Current collateral Forecast collateral


value values
IFRS 9 LGD for all
LGD accounts
12 month/ 12 month /
Current LGD Lifetime FL Lifetime Forward

ECL model component - EAD


Adjustment Looking LGD

Key Challenge: Lifetime EAD


Revolving products
(e.g. credit card, line of credit)

=

Time to default

Projected utilisation rate


Time to default
Historical utilisation rate

0 1 2 3 0 1 2 3

Origination year
2001 80% 75% 68% 74% 2001 80% 75% 68% 74%
Origination year

Development pattern 2002 85% 80% 81% 81%


2002 85% 80% 81%
projection techniques
2003 88% 81% 2003 88% 81% 75% 74%

2004 81% 2004 81% 79% 75% 74%

Considerations
Aggregation of data into homogenous risk groups
Stability of development patterns and representativeness of historical experience
Alternative methods such as developing regression models

13
Bucket 1 and Bucket 2
Macroeconomic Definitions
Alignment Required Model

Basel II IFRS 9 12 months Forward 12 months


Looking Forward Looking
12 Month PD 12 Month PD Adjustment
PD PD
IFRS 9 PD for all
accounts

Life-time PD Lifetime Forward Lifetime Forward


Life-time Definition Looking
structure Looking PD
Adjustment

12 month/ 12 month /
Current balance Amortisation IFRS 9 EAD for all
EAD Lifetime FL Lifetime Forward
and limit profile accounts
Adjustment Looking EAD

Current collateral Forecast collateral


value values
IFRS 9 LGD for all
LGD accounts
12 month/ 12 month /
Current LGD Lifetime FL Lifetime Forward

ECL model component Forward Looking


Adjustment Looking LGD

Key Challenge: Forward Looking


Leveraging Existing Stress Testing Process:
Current Stress Testing Process: Additional modification:

Unbiased best estimate Monte Carlo Simulation


Determine Stress Scenarios forecast for MEV forecast

Linkages for non-stress Linkages for areas not


Economic Linkage Model periods covered

Sensitivity and back


Determine Stress Outcomes testing
Overlay Framework

Considerations
Lack of data required to build a statistical model
Require multiple year of Macro-economic forecast
Shift in mentality from stress testing to forward looking

14
ECL model component Triggers
Key Challenge: Relative and Absolute Credit Quality

Absolute credit quality Relative credit quality


no Has the credit risk increased significantly since initial
Does the financial asset meet the definition
of low credit risk at the reporting date? recognition?
If more than 30 days overdue -
> yes (rebuttable presumption)
Financial asset is below investment grade
no -> likely yes but significance of increase
has to be determined

yes yes

Credit-impaired
Does the financial asset meet the credit-impaired definition
(same definition as in IAS 39)?
no yes
1 2 3
Performing Deterioration of credit quality Credit-impaired
>12-Months-EL > EL over Lifetime > EL over Lifetime
(interest revenue on gross basis) (interest revenue on gross basis) (interest revenue on net basis)

15
ECL model component Triggers
Key Challenge: Definition of significant increase in credit risk
Quantitative Triggers:

Changes in credit ratings Changes in internal price Changes in external market


Drop in external credit ratings indicators of credit risk indicators
Drop in internal credit ratings Significant deterioration of loan to Drop in borrowers bond prices
value ratio Increase in credit default swap
Breaches in financial covenants prices for borrower

Qualitative Triggers:

Changes in business, financial Changes in operating results Other qualitative inputs


or economic conditions Actual or expected decline in Trading suspension of listed shares
Industry downturn revenues/margins on exchange
Increase in unemployment rates Working capital deficiencies Litigations likely to have material
impact Profit warnings

16
Challenges to comply with IFRS 9
Banks face a number of challenges in meeting their desired level of IFRS
9 compliance
IFRS 9 Requirements Challenges Desired level of
compliance

Range of data requirements Regulatory expectation


Lack of data Correct models
Sophisticated modelling
Industry Practice
expectations Expert Judgement Peoples and skills

Uncertainty in
Expert judgement based Implementation
expectation Auditor expectation
decision
Systems and Interpretation of
processes the Standard
High quality
Holistic governance process Cross-border
Timelines implementation
exposure

17
Results from Latest Survey
There is still a significant amount of work to be done in APAC.
Understanding IFRS 9 Detailed Design
14 20
12
10 15
8
10
6
4 5
2
0 0
0% - 20% 20% - 40% 40% to 60% 60% - 80% 80% - 100% 0% 0% - 20% 20% - 40% 40% to 60% 60% - 80% 80% - 100%

Model Development Test / Implementation


20 25

20
15
15
10
10
5
5

0 0
0% 0% - 20% 20% - 40% 40% to 60% 60% - 80% 80% - 100% 0% 0% - 20% 20% - 40% 40% to 60% 60% - 80% 80% - 100%

18
Results from Latest Survey
The industry view currently varies on the best approach to adopt when it
comes to incorporating forward looking in their models

APAC Others
Approach to incorporate Forward Looking
25

20

15

10

0
Bottom-up model Bottom-up expert Top-down quantitatively Top-down expert A combination of the To be determined
driven enhancements to judgement based assessed overlay judgement overlay above
PD, LGD and EAD enhancements to PD,
LGD and EAD

19
Further Reading and Q&A

IFRS 9: Impairment, Global IFRS 9: Expected Credit Losses


banking industry benchmark https://www.pwc.com/ca/en/accounting-advisory-
services/publications/us2014-06-ifrs-9-expected-credit-
Available on Request losses.pdf

20