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International Financial Reporting Standard 9 (IFRS 9)

KnowCo’s solution for IFRS 9 responds to all requirements of the Standard applicable to non-complex

institutions, from governance, classification and measurement of assets and off-balance sheet

exposures, to impairments and regulatory reporting. In consultation with KnowCo personnel, client

firms transpose their data and rules into the solution to calculate Expected Credit Loss (ECL) and

generate the required regulatory returns and data for disclosure and MI.

Overview

The International Accounting Standards Board has developed IFRS 9 to address the shortcomings of

the incumbent IAS 39 standard, which exacerbated the financial crisis by curbing institutions’ ability to

fully anticipate and absorb future credit losses.

From 01/01/2018 institutions accounting under IFRS standards will once again be able to fully provide

for ECLs, but strict principles-based rules are intended to prevent the use of provisions to mitigate

income volatility.

The changes are radical and important, because they will ultimately affect financial institutions’ P&L

and capital, notwithstanding transitional provisions under discussion, aimed at lessening the ‘cliff

effect’. So, each firm’s adoption of the new standard must be subject to rigorous governance

disciplines.

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Governance Firms must make determinations and judgment calls, which will need to

Be documented as policy (and consequently given effect by supporting process and assurance

mechanisms)

Be subject to review, annually or more often if exposure profiles change

Evidence sanction by the Board (or the Board Audit Committee) and

Withstand scrutiny by auditors and supervisors (see Latest Updates: ‘IFRS9 Policy and

Interpretation’ at www.knowco.co.uk )

Objective of Impairment Requirements The objective of the impairment requirements is to recognise lifetime expected credit losses for all

exposures for which there has been a significant increase in credit risk since initial recognition -

whether assessed on an individual or collective basis - considering all reasonable and supportable

information, including that which is forward-looking.

So, at least as frequently as each reporting date, firms must assess whether the credit risk on an

exposure or group of homogenous exposures has increased significantly, since origination.

Expected Credit Loss Calculation Institutions may initially set ECL parameters at business model (portfolio/product) level. These

parameters are applied at the account level to calculate the ECL. Users can also change these values

for an account before calculating the ECL, giving a reason for the change:

To be compliant with IFRS 9, firms will need to

analyse their business lines and their related

business objectives according to the new

classification rules, in order to determine the

treatment of expected losses.

This applies to virtually all types of financial assets

and off-balance sheet exposures.

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Caution: EU institutions should be aware that the EBA IFRS9 guidelines say “…credit institutions

should avoid using it [the 30+ days past due 'rebuttable presumption'] as a primary indicator of

transfer to lifetime ECL”. So you should have other indicators of significant increase in credit risk

documented in your credit risk management policies and procedures.

Credit Impairment The IFRS9 3-stage approach is based on the change in ECL since origination. Exposures may move

through the three stages if and as credit quality changes:

Stage 2 includes exposures that have had a significant increase in credit risk since initial

recognition. For these exposures, Lifetime ECL is recognized, but interest revenue is still

calculated on the gross carrying amount. Lifetime ECL is the expected credit loss for the life of

the exposure - the weighted average credit losses with the deemed probability of default (PD)

as the weight, discounted to present value at the EIR.

‘When information that is

more forward-looking than

past due status (either on an

individual or a

portfolio/business-line basis)

is not available without

undue cost or effort, a firm

may use past due status

alone to determine whether

there have been significant

increases in credit risk since

initial recognition.’

• Stage 1 includes financial instruments

that have not had a significant increase

in credit risk since initial recognition, or

that have inherent low credit risk. For

these exposures, 12-month ECL is

recognized - the expected result from

the default rate predicted as most likely

in the forthcoming year. Interest revenue

is calculated at the effective interest rate

on the carrying amount of the exposure,

without reduction for ECL.

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Stage 3 includes exposures that have objective evidence of impairment at the reporting date.

For these exposures, lifetime ECL is recognized but interest revenue is calculated, at the EIR,

on the net carrying amount (i.e. net of ECL and any write-off).

Important Note: Note the difference between ECL status and Impairment status – not a direct relationship. Impairment relates to counterparties and groups of financially interdependent counterparties, whereas ECL is applied at account level. You may have little or no ECL in respect of a heavily-impaired counterparty (strong collateralisation) and significant ECL in exposures at Stage 1 impairment (high-risk, uncollateralised products).

Write-Off and Recovery The solution captures all write-offs and any subsequent recoveries, for accounting, MI and FINREP

reporting purposes.

Regulatory Reporting

In the EU there is mandatory FINREP reporting. The UK PRA has specified 6 quarterly FINREP reports

for even the smallest institutions (assets under £5bn) which the KnowCo solution produces.

KnowCo’s IFRS 9 solution The KnowCo IFRS 9 solution is built upon its mature stress testing engine ‘KST’ which captures data at

a cash flow level of granularity. It then applies the business rules that determine IFRS9 exposure

classification and measurement, impairment and reporting values. These are calculated using

expected loss parameters and then present-valued at the ‘Effective Interest Rate’, which is calculated

taking into account attributable fees and costs.

The place where IFRS9 lives, in your firm…

Our solution provides the essential infrastructure and functionality required by IFRS9 for any firm:

• the place where data is stored (potentially large volumes, over long periods),

• where the Effective Interest Rate is calculated

• into which the 12-month and Lifetime probabilities of default, and the loss-given-default, credit

conversion factor and exposure-at-default percentages are fed, in order to be able to calculate

expected credit losses,

Write-off is a de-

recognition event and

the carrying amount of

the asset is therefore

reduced by the amount

of the write-off. As ever,

the reason for the

intervention and the ID

of the person making the

change are both

captured

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• where nominal ECL values are present-valued at the EIR to give discounted values for accounting

and reporting purposes.

• where parameters are set for automatic movement between impairment stages, according to

each institution’s own business rules,

• where portfolio-level Impairment Stage and ECL can be overridden, for individual counterparties

and accounts respectively (by those authorised to do so),

• where the regulatory reporting categorisation (for e.g. FINREP 5.1 as below) is set and maintained,

from which regulatory returns and internal MI are produced.

Practical Answers

In the course of building the solution we have addressed the many practical and operational issues

which will arise for all firms in complying with what is in essence a high-level, principles-based

Standard – long on ‘what to do’, but short on ‘how to do it’. For example, we’ve built-in standard

functionality such as Stage 3 impairment at 60+ days past due, but we’ve parameterised those

functionalities, so that users can flex them to align with whatever their policy might be.

Once ECL calculations are completed, disclosures and reporting can be produced in accordance with

the required FINREP (or other) returns, with annual disclosure and internal management information

reports also available.

In the screenshot above you can see FINREP 5.1 ‘Loans and advances other than held for

trading…’ generated, together with a drill-down version of the same report for detailed analysis.

The drill-down is to account level (bottom-right). K-IFRS9 is completely transparent to end-users.

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All source data, together with retained results data, is stored in the solution’s rich database, located

on the client institution’s servers.

The history of changes, and what, why and who did them, are stored in the system and can be viewed for each portfolio, account number, client or counterparty.

Why KnowCo’s IFRS 9 solution?

A proven, robust platform housed on your servers

Business Model classification according to each firm’s business lines

Automated data loading, eliminating spreadsheet risk

Automated determination of Effective Interest Rate

Automated ECL calculation and present-valuing at general (business line) and specific

(account) level, according to each client’s business rules

Manual override to individual impairment levels and ECL

All overrides must carry a justification before the system will record them. A full

access/activity log is kept.

Our IFRS9 database is loaded automatically by K-ETL

(extract, transform and load) code written by KnowCo

developers for each client, according to the data sources

provided and the data mapping agreed between

KnowCo and the institution. KnowCo consultants work

with each client firm to configure the solution.

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Captures all history to track and report changes and trends in ECL per portfolio, via MI and all

required regulatory reports such as FINREP

Both system and MI highly configurable-to-client

Deep domain expertise, aimed at total compliance

Support for policy, process and assurance alongside a complete technical solution.

Call to Action

Since we established KnowCo 7 years ago, we have supported almost 40 institutions in successfully meeting regulatory challenges of all kinds.

Contact us now for an informal, confidential discussion about your own IFRS 9 project, and how

we can help.

Please visit www.knowco.co.uk for more IFRS 9 resource or contact Paul Ashton, Director, at paul.ashton@knowco.co.uk or call him on +44 (0)7799 113535.

This screenshot shows the system

capturing a partial write-off (for

reporting purposes you need to

distinguish between partial and

total write-offs). All such actions are

available to authorised users only

and in every instance a reason for

the action is captured – otherwise

the operation can’t be completed

Authorised users can change, at

individual account level, any or

all of 12-month PD, Lifetime PD

and Exposure at Default, Credit

Conversion Factor (off-balance

sheet exposures) and Loss

Given Default – the factors

which drive Expected Credit

Losses. Again a reason must be

captured, and a full history is

maintained in the database