On 15 April 2019 a letter was sent from the Prudential Regulation Authority (PRA) to CFOs of selected deposit-takers, which provided an update and the main thematic findings from written auditor reporting, in relation to the implementation of Expected Credit Loss (ECL) models under IFRS 9. A year on from the first implementation of IFRS 9, there are clearly some recurrent themes emerging across the industry. In addition, there is a recognition of the need for the models to evolve, primarily to address known weaknesses and promote consistency. Jaywing's Mark Vickers looks at what this is likely to mean for many UK lenders, along with some practical guidelines to help meet PRA expectations.

Since 1 January 2018, most UK lending institutions have been required to adhere to the IFRS 9 accounting standard for calculating impairment. For many firms, this heralded a period of transformational change, with a need to develop a first-generation suite of forward-looking risk models and embed infrastructure enhancements to enable them to be productionised.

Now for the first time since the initial implementation, the PRA has indicated where the focus is expected to lie over the coming year and beyond. A number of prevalent weaknesses have been identified and will come under increased scrutiny by auditors. While in some cases appropriate solutions remain subject to debate, it is clear that industry best practice is evolving.    

Read our guide to the PRA IFRS 9 review, where we discuss the main points highlighted and make suggestions for how firms can begin to tackle the ongoing challenges in a way that both satisfies regulatory requirements and fosters continuous improvement in risk management.

The four key areas are:

• Model and data limitations: the first-generation models were often subject to weaknesses in data quality and availability, a lack of model robustness, inadequate validation and, consequently, an over-reliance on Post-Model Adjustments (PMAs) to cater for their shortcomings.
• Multiple economic scenarios: the economic scenarios that drive forward-looking estimates were often found to be unrealistic or insufficient in range - modelling approaches must evolve in order to capture non-linearities and deal with economic uncertainty.
• Significant increase in credit risk (SICR): many firms? models were found to not be sufficiently reactive to indicators of SICR - while initial approaches varied, some common metrics are now emerging across the industry.
• Lifetime of an exposure: approaches used to determine the product lifetime for ECL calculations were inconsistent, particularly for revolving products - assumptions based around credit reviews and de-recognition criteria may need to be revisited. 

Some of these areas were discussed in a webinar hosted by UK Finance last month - on 11 June, we turn our attention to the challenges of stress testing under IFRS 9. Book your place on this free webinar to hear technical and practical guidance for implementing successful IFRS 9-based stress tests.