Over the last couple of years, we have observed how regulatory challenges are forcing firms to re-examine the cost, efficiency, sustainability and transparency of their risk management requirements. The cost of managing risk is increasing and the banking battleground is more competitive than ever, with new nimble entrants and exciting new digital propositions entering the market place.
The cost of IFRS 9
IFRS 9 moved accounting impairment from an incurred loss methodology to a multi stage, forward looking process, which combines modelled outputs and expert judgement components to calculate compliant loan loss provisions. IFRS 9 expected credit loss (ECL) models are embedded into larger strategic information systems that manage the flow of data from various sources into the model and handle the aggregation and reporting of model outcomes.
Such strategic systems are critical to meet the supervisory guidance on model risk management requirements set out in SR Letter 11-7 “…Model calculations should be properly coordinated with the capabilities and requirements of information systems. Sound model risk management depends on substantial investment in supporting systems to ensure data and reporting integrity, together with controls and testing to ensure proper implementation of models, effective systems integration, and appropriate use.”
The majority of the existing lenders in the market were too late to deliver a strategic IFRS 9 solution upon adoption of the new standard in January 2018. We now observe varying levels of sophistication in the market with many firms relying on tactical model execution processes, which are both costly and increase BAU resource requirements. These tactical implementations by design quite often obscure managements understanding of the underlying drivers the IFRS 9 ECL models, making it difficult to explain changes in loan loss provisions.
Current tactical IFRS 9 implementations are simply not sustainable and banks recognise that action is required to reduce the operational and compliance risks of these solutions. A streamlined model suite and reporting process is the number one critical enabler to manage the commercial impact of IFRS 9 and deliver cost efficiencies. This has resulted in the launch of IFRS 9 optimisation programmes to land integrated solutions to help address efficiency gaps.
Moreover, new entrants to the market are confronted with the staggering costs associated with setting up robust IFRS 9 processes. Whilst they have an opportunity to avoid the pitfalls of tactical implementations, they lack the internal experience and resources that these standards demand for a successful strategic implementation.
The case for change
As already indicated, lenders are adopting measures to further industrialise and automate calculation and reporting processes, whilst decreasing overall spend on these activities. Two options are recurring themes when we discuss the business case for change with firms:
- Investment in technology to deliver improved and more consistent solutions, which promote increased efficiency across the business on an end-to-end basis. This is consistent with improved automation and digitalisation of risk and finance.
- Use of managed services to remove processing pain points around the execution of models within a controlled framework.
Both aforementioned strategies can help lenders simultaneously cut costs, lower compliance risks and pursue their business strategies. The case is simple: Quicker cycle times, greater automation and fewer manual interventions will save money and allow staff to focus attention on more productive purposes such as analytics and portfolio management. This will provide better insight on portfolios, directly leading to better risk management and pricing decisions.
More specifically, this will free up teams to focus on value add analytics and insight, as opposed to cranking the handle on manual processing. Furthermore, as each firm moves from a fragmented process to an integrated solution, the management time required to establish controls, complete reviews and create reports will reduce.
Each lender has unique challenges; however, generally speaking a managed service is better suited to address the needs of smaller digital lenders and challenger banks.
How managed services can help
The underlying premise of an IFRS 9 managed service is simple; the service provider manages the complex, repetitive process steps requiring high capacity IT processing power and sophisticated calculation engines. However, more importantly, the governance of the bottom line capital and impairment figures, such as the definition of credit risk models and expert judgement remains under the lenders full control.
Many organisations do not have the internal resource to develop sophisticated in-house risk execution frameworks. A managed service provider offers years of experience in a packaged service combining offshore delivery models, local industry expertise and sophisticated technology. This helps to save costs, whilst enabling management to focus on core business activities with reduced exposure to model risk, IT risk and change risk. Furthermore, managed services provided by large audit and accounting firms such as Deloitte, provide management with access to unique industry views and benchmarks.
In a nutshell, the service relieves banks from the tactical solution that they currently have in place, and allows the bank to transition to a robust IT solution with the following benefits:
- BAU resource cost base and attrition risk reduction
- IT change risk and cost reduction
- Credit risk synergies and consistency
- IFRS 9 industry benchmarks
- Credit analytics and reporting insight from the managed service provider
- Optimised end-to-end processes
Therefore, a managed service gives banks access to a sophisticated strategic solution that meets the reporting needs of the credit risk function.
The added benefit of benchmarks
Due to the complexity of the IFRS 9 standard, it is nearly impossible to compare aggregate provisions or individual component outputs with competitors without an explicit known reference point, stripping out for example differences in the treatment of forward looking macro-economic information or stage allocation. A managed service provides the benefit of providing a detailed, account level, peer benchmarks that allows a true like for like comparison of impairments. These benchmark comparisons could be provided on the portfolio, models or macro-economic forecasts.
The case for improving your productivity
By running an efficient and effective back-office credit risk measurement process, the focus can shift to the interpretation of results and shaping front office strategies, such as lending, pricing, and so on. This approach will allow organisations to secure a competitive advantage in terms of managing cost and operational risk, as well as using analytical insight to support sustainable customer growth within risk appetite.