G20 (2009): Strengthen loan loss accounting using broader range of information aiming at greater stability IFRS 9: 3S-approach replaces Incurred Loss (IL)-approach Basel Committee Guidelines: Are claims justified? higher model quality and backtesting Macroeconomic projections Denouncing shortcuts (e.g. 30d past due) For lack of empirical evidence: Let’s use simulations Revolving 10Y-loan portfolio, infinitely granular follows Moody’s US-Corp. migration statistics, transfer S1/2: 3notch downgrade (papers.ssrn.com/sol3/papers.cfm?abstract_id=2187515

1. Dr. David Gruenberger, CPA
Head of the IFRS Enforcement Division
Austrian Financial Market Authority
(all views expressed are personal)
GLC Risk Management Forum 10-11 Sept 2015
IFRS 9: London versus Basel

2. 2
The Challenge for Standard-Setters
G20 (2009): Strengthen loan loss accounting using broader
range of information aiming at greater stability
IFRS 9: 3S-approach replaces Incurred Loss (IL)-approach
Basel Committee Guidelines: Are claims justified?
higher model quality and backtesting
Macroeconomic projections
Denouncing shortcuts (e.g. 30d past due)
For lack of empirical evidence: Let’s use simulations
Revolving 10Y-loan portfolio, infinitely granular follows Moody’s
US-Corp. migration statistics, transfer S1/2: 3notch downgrade
(papers.ssrn.com/sol3/papers.cfm?abstract_id=2187515)

3. 3
Buildup of Provision and P&L Effect
Average Allowance
S1 + S2 + S3 = 75 BP
S2 + S3 = 73 BP
S3 (Incurred Loss) = 47 BP
20
30
40
50
60
70
80
90
100
110
1985q1
1986q1
1987q1
1988q1
1989q1
1990q1
1991q1
1992q1
1993q1
1994q1
1995q1
1996q1
1997q1
1998q1
1999q1
2000q1
2001q1
2002q1
2003q1
2004q1
2005q1
2006q1
2007q1
2008q1
2009q1
2010q1
2011q1
3S IL
Volatility of Income from bearing Credit Risk
IL Approach: σ = 13,9 BP
3S Approach: σ = 15,3 BP
0
20
40
60
80
100
120
1 3 5 7 9 111315171921232527293133353739
S1+S2+S3
S2+S3
S3 = IL

4. 4
Interpretation
Frontloading EL-accounting: higher provisions
3S versus IL-Approach: Slightly higher volatility
3S extends scope from “bad” loans to “good and bad” loans whose credit
qualities (e.g. ratings) are correlates in time
More correlated inputs - more variance

5. 5
Classic (3 Notch) versus Lenient (6 Notch)
Implementation of Stage 1-2 Transfer
Average Allowance
3S Classic (S1, 2, 3) = 75 BP
3S Lenient (S1, 2, 3) = 67 BP
Volatility of Income from bearing Credit Risk
3S Classic: σ = 15,3 BP
3S Lenient: σ = 15,4 BP
20
30
40
50
60
70
80
90
100
110
1985q1
1986q1
1987q1
1988q1
1989q1
1990q1
1991q1
1992q1
1993q1
1994q1
1995q1
1996q1
1997q1
1998q1
1999q1
2000q1
2001q1
2002q1
2003q1
2004q1
2005q1
2006q1
2007q1
2008q1
2009q1
2010q1
2011q1
3S Lenient
3S Classic
0
20
40
60
80
100
120
1 3 5 7 9 111315171921232527293133353739
3S Lenient
3S Classic

6. 6
Interpretation
Lenient policy reduces the allowance
This justifies Basel GL: Governance, strict policy, backtesting
Lenient implementation even slightly increases
volatility. Why?
Fewer transfers (impairments), but:
The longer you wait to provide lifetime losses, the higher your fall (cliff
effect)
Lenient policy will not reduce volatility and cause trouble with
regulators/auditors

7. 7
Empirical and Modelled Income correlated with
the GDP-Cycle
0%
10%
20%
30%
40%
50%
60%
t-8q t-7q t-6q t-5q t-4q t-3q t-2q t-1q t t+1q t+2q t+3q t+4q t+5q t+6q t+7q
R(3S,GDP)
R(IL,GDP)
R(Empirical
LL,GDP)

8. 8
Interpretation
3S Approach will not be forward looking per se
Reason: Credit quality of good and bad loans changes simultaneously in
the cycle, a recession affects all clients (highly correlated)!
Irrespective of approach: Projection quality counts!
US-Banks mainly used 90d-past due data instead of current ratings, so
their loan losses lag behind the cycle
Disincentive to be forward looking (science: “herd behaviour,
psychological repression, avoidance of negative market signals”)
Consequences
Disincentive to be forward looking requires supervisory scrutiny
- market demand probably insufficient
This justifies Basel GL-quality focus and ban on 30d past due shortcut