OSFI Perspectives on High Quality Implementation for Expected Credit Losses and OSFI s IFRS 9 Project Plan

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Neil McLaughlin
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Project Plan Acumen 2015 Financial Institutions

1 OSFI Perspectives on High Quality Implementation for Expected Credit Losses and OSFI s IFRS 9 Project Plan Acumen 2015 Financial Institutions Update Ruby Garg Director Accounting Policy Division June 9, 2015

2 Outline OSFI Accounting and Regulatory Update 1. Accounting standards and OSFI 2. OSFI s IFRS 9 Project Plan 3. Implementation of Expected Credit Losses 4. Closing remarks 2

3 Accounting Standards and OSFI Accounting standards are important to OSFI OSFI is responsible for assessing the safety and soundness of Canada s federally regulated financial institutions (FRFIs). Accounting is important because: Financial statements are a leading indicator of performance. OSFI s assessment of a FRFI s overall financial performance depends upon the FRFI s audited financial statements. OSFI relies on FRFIs external auditors for the fairness of the financial statements. OSFI, through its membership in the BCBS and the IAIS 1, liaises with standard setters, responds to proposals and engages in dialogue with key stakeholders on relevant IFRSs for FRFIs. 1 Basel Committee on Banking Supervision (BCBS) and International Association of Insurance Supervisors (IAIS) 3

4 Accounting Standards and OSFI Significant changes to IFRSs in the future Significant revisions are currently under development for key accounting standards including financial instruments, insurance contracts, leases, and the conceptual framework. There is an increased emphasis on enhancing disclosures since the financial crisis. Significant changes to accounting standards require: Early involvement Active participation Close consultation and communication Responding to discussion papers or exposure drafts 4

5 OSFI s IFRS 9 Project Plan Overview of OSFI s IFRS 9 project Formed cross-sector work team to assess impact to existing OSFI guidelines/advisories and returns. Propose changes to guidelines and regulatory returns. Consult with industry, auditors, others. OSFI Accounting and Capital Policy Development (incl. industry consultation) OSFI Return Changes (incl. industry consultation) Implementation Jul 2014 Summer 2015 Dec 2015 Jun 2016 Nov 2017 Jan 2018 Final IFRS 9 Publish draft revisions of OSFI accounting guidelines for consultation Finalize guidelines Finalize returns Effective date for D-SIBs Effective date for Dec year ends 5

6 Background Basel Committee on Banking Supervision (BCBS) Guidance on sound credit risk assessment and valuation of loans 1 was published in The BCBS Accounting Experts Group (AEG) has revised the 2006 Guidance to reflect the move to an expected credit loss (ECL) accounting model. BCBS Consultative Document - Guidance on Accounting for Expected Credit Losses 2 was issued on February 2,

7 Objective and Scope of Guidance The updated Guidance provides supervisory requirements for sound credit risk practices to encourage a high quality, robust and consistent implementation of an ECL accounting model in accordance with the applicable accounting framework. The Guidance is not a converged solution between the IASB and the FASB accounting models. The Guidance sets out supervisory expectations for internationally active banks to ensure a high quality implementation of ECL accounting frameworks. 7

8 Principles Main section: Supervisory principles for credit risk practices that impact the accounting estimate of allowances. Principles 1. Responsibilities of the Board and Senior Management 2. Components of sound ECL methodologies 3. Appropriately grouping lending exposures based on shared credit risk characteristics 4. Adequacy of the allowance and requirements on collective or individual assessments 5. Policies and procedures on validation of internal credit risk assessment models 6. Use of experienced credit judgement and consideration of forward-looking information 7. Integration of accounting, credit risk and capital management 8. Enhanced disclosures Responsibilities of supervisors 8

9 Appendix IFRS appendix: outlines supervisory requirements specific to IFRS jurisdictions. Appendix A1. Loss allowance at an amount equal to 12-month ECL A2. Assessment of significant increases in credit risk A3. Use of practical expedients/simplifications 9

10 Main section: Principle 1 Responsibilities of the Board and Senior Management Integrates elements of Basel Core Principles 17. Distinguishes between responsibilities of the Board and Senior Management. Emphasises that the Board/Senior Management have responsibility for maintaining allowances for all lending exposures at the appropriate level and creating, implementing and updating policies and procedures on credit risk practices, as well as reporting and oversight responsibilities. 10

11 Main section: Principle 2 Components of sound ECL methodologies A sound credit risk methodology should include clear definitions of key terms related to the estimation of ECL, to encourage consistency in interpretation and application. Banks should have in place suitable processes and systems to appropriately identify, measure, evaluate, monitor, report and control the level of credit risk. All assumptions, polices, procedures and controls around credit risk practices should be documented. ECL assessment should not be limited to narrow set of inputs to estimate ECL and should be consistent period to period. 11

12 Main section: Principle 3 Appropriately grouping lending exposures based on shared credit risk characteristics. Exposures should not be grouped such that changes in credit risk in a part of the portfolio/pool is masked by the performance of the portfolio as a whole. Re-segmentation should occur when new information is received or bank s expectations of credit risk have changed for the group of exposures. Principle 4 Adequacy of the allowance and requirements on collective or individual assessments Exposures that can not be assessed individually should be placed in a group and assessed collectively to appropriately capture forwardlooking information, including macro-economic factors. 12

13 Main section: Principle 5 Policies and procedures on validation of internal credit risk assessment models A validation framework should include elements on governance, roles and responsibilities, validation scope and methodology, documentation and independent review of the model validation process. Principle 6 Use of experienced credit judgement and consideration of forward-looking information Banks cannot rely solely on past due information when measuring ECL. Banks must use experienced credit judgment to incorporate all reasonably available forward-looking and macroeconomic factors when estimating ECL. Banks cannot ignore relevant information that is reasonably available and which can improve the estimate of ECL. 13

14 Main section: Principle 7 Integration of accounting, credit risk and capital management Banks credit risk practices should meet fundamental requirements and procedures, including having the appropriate tools to identify, assess, and price credit risk appropriately. Processes should be closely integrated for both accounting and capital adequacy purposes. Principle 8 Enhanced disclosures Banks should provide both relevant qualitative and quantitative disclosures that enhances understanding of ECL estimates and improves comparability over time. 14

15 Main section: Principle 9-11 Responsibilities of supervisors Supervisors are to periodically evaluate the effectiveness of a bank s credit risk practices. Supervisors should be satisfied that a bank s credit risk practices are robust and that ECL measurements are reasonable and prudent. Supervisors should communicate deficiencies identified and hold banks accountable for remediating those deficiencies. 15

16 IFRS Appendix: A1. Loss allowance at an amount equal to 12-month ECL Banks should always measure ECL for all lending exposures, and a nil allowance will be rare. 12 month ECL is not only the losses expected in the next 12 months; rather, it is the expected cash shortfalls over the life of the instrument/portfolio due to loss events expected to occur in the next 12 months. Banks must adjust its estimate of 12-month ECL to adequately reflect changes in credit risk, even if changes are not judged to be significant. 16

17 Appendix: A2. Assessment of significant increases in credit risk The assessment of significant increases in credit risk must include forward-looking information and macroeconomic conditions. Banks should have processes in place to determine significant increases in credit risk in a timely and holistic basis, considering the examples set out in the guidance. The transfer of lending exposures from an amount equal to 12- month ECL measurement to lifetime ECL should generally not rely solely on past due information such as delinquency. 17

18 Appendix: A3. Use of Practical Expedients IFRS 9 includes a number of practical expedients to ease the implementation burden for wide range of companies applying IFRS 9. Use of practical expedient by internationally active banks should not result in a low-quality implementation of an ECL framework. Justifications for the use of exemptions by banks should be documented and will receive increased scrutiny by Supervisors. IFRS 9 refers to the term investment grade as an example of low credit risk. This is only an example and the Committee does not consider all investment grade exposures as low credit risk. Banks cannot rely on the 30 days past due simplification as the primary basis for transfer to lifetime ECL, as credit risk increases significantly before exposures become past due. 18

19 Comment Letters Comment period closed on April 30 th. BCBS Committee received 47 comment letters with wide representation: Type Region Banks 10 International 10 Banking Associations 21 Africa 1 Auditors 5 Americas 5 Standard Setters 4 Asia 4 Other 7 Europe 22 Oceania 3 Other 2 Total 47 Total 47 19

20 Comment Letters Comments supported: Heighted expectations for internationally active banks. Inclusion of guidance on forward looking, the transfer to life time and creating consistency in the use of simplifications. Concerns raised on potential costs and complexity on meeting aspects of the Guidance. 20

21 Comment Letters Forward-looking information: Respondents encourage that the guidance revert to IFRS 9 requirement that ECL estimates incorporate forwardlooking information that is reasonable and supportable. Materiality: Respondents encourage that the guidance include a link to the concept of materiality underpinning financial reporting. Respondents suggest that the use of practical expedients be linked to materiality. 21

22 Comment Letters Symmetry: Respondents encourages BCBS to highlight in the Guidance that an ECL framework deals with both deterioration and improvement in credit quality, consistent with the accounting framework. Transfer to lifetime ECL: Guidance includes a list of considerations that could result in lifetime ECL recognition. Respondents expressed concern that the list can create a check list mentality. 22

23 Next Steps Review comments letters received during comment period. Work toward finalization of the Basel Guidance throughout

24 Closing Remarks Continual changes require constant communication Accounting standards are important to OSFI. OSFI supports the use and development of high-quality global accounting standards. Preparers and users of financial statements must be proactively engaged in the accounting standard setting process to ensure that Canadian concerns are appropriately addressed. Prudent to monitor the IFRSs developments and understand the interaction with regulatory frameworks. 24

25 Questions 25

Guideline Impact Analysis Statement

Guideline Impact Analysis Statement IFRS 9 Financial Instruments and Disclosures June 2016 1. Introduction The International Accounting Standards Board (IASB) issued the final version of International