Adoption of the IFRS 9 provisioning norms brings along unique set of implementation challenges towards estimation of credit losses

An analysis by Crisil Risk Solutions (CRS) reveals the inherent challenges impeding transition to the IFRS 9 guidelines on expected credit losses, for lenders across both retail and non-retail segments.

In its previous two papers in the IFRS 9 series, CRS highlighted the key implications of the new norms and their likely impact on provisions compared to current levels separately for the non-retail and retail segments. This study shall focus on the unique challenges likely to be faced by lenders in pursuit of compliance with the new guidelines.

Under IFRS 9, the provisioning would be based on the risk profile of the asset (the probability of default i.e. PD) and potential recovery after default, even for such standard (performing) assets. This principal shift in the way credit risk is measured and provisioned for shall pose a number of implementation challenges for lenders.

For borrowers exhibiting an increase in credit risk but who have not defaulted, the provisioning is required to factor in expected credit losses (ECL) over the entire remaining tenor of the asset. This necessitates a robust framework to monitor credit risk movement since initial recognition (for staging) and for provisioning based on expected credit losses. Consequently, lenders need to have a comprehensive methodology for risk rating / pooling of their borrowers, and strengthen practices around recovery data collection.

Outside the theoretical framework, movement to IFRS 9 shall also entail a number of practical challenges for lenders with respect to its on-the-ground implementation. Ensuring availability and integrity of data will be of principal importance, with technology playing a major role towards mitigation of these challenges. Leveraging technology will also help towards ensuring an institutionalized roll-out of the functional frameworks across the lending institution.

Throughout the implementation, managing multiple, possibly conflicting views from across functions such as risk, credit, finance and technology will also imply a need for active stakeholder management.

Finally, the estimation of the impact of the new norms over current provisioning levels is likely to be challenging, especially for retail segments. Furthermore, this impact is expected to vary widely from lender to lender.