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WHAT BASEL SAYS ABOUT
EXPECTED CREDIT LOSS
(ECL)
Graham Dyer
Sr. Manager – Financial Institutions
Grant Thornton
Tuesday March 24th, 2015
PRESENTED BY:
Emily Bogan
Sr. Risk Management Consultant
Sageworks
Questions
+ A copy of the slides and webinar recording will be emailed to you following the
webinar
+ To ask a question during the webinar, enter it into the chat box in the
GoToWebinar panel on right side of screen:
+ Brief Q&A held at end of webinar
About Sageworks
+ Financial information company that provides credit and risk
management solutions to financial institutions
+ Data and applications used by thousands of financial
institutions and accounting firms across North America
+ Named to Inc. 500 list of fastest growing privately held companies in
the U.S.
+ Named to Deloitte’s Technology Fast 500
+ NC Tech Awards: Excellence in Customer Service
About Grant Thornton
At Grant Thornton, we provide clear insights and practical solutions, helping you navigate
the complexities of today's business landscape. Our financial services is one of Grant
Thornton’s largest industry practices and consists of
+55 dedicated partners
+Over 500 professionals
For more than 80 years, we have been serving financial services companies and financial
institutions. Nationally, we have worked with
+2,200 public and private financial services companies
+350 are banking clients
The practice is comprised of senior partners who have served in various C-suite executive
roles in the industry; while others have served as former bank regulators. This experience
enables us to provide a unique, strategic perspective on current industry matters, as well
as implement best practices to position leaders for the future.
To learn more, visit us at www.grantthornton.com.
Who will be speaking?
Emily Bogan
Sr. Risk Management
Consultant
Sageworks
Graham Dyer
Sr. Manager – Financial
Institutions
Grant Thornton
Ed Bayer
Vice President
Sageworks
Learning Objectives
+ What is the Basel Committee on Banking Supervision (BCBS)?
+ What document did they release?
+ What is the document’s purpose?
+ Why should I care?
+ Principles underlying the document
+ Risk management maturity model
+ Key takeaways
+ Conclusion
What is the Basel Committee on Banking
Supervision (BCBS)?
+ Basel Committee on Banking Supervision (BCBS)
+ Primary global standard-setter for the prudential regulation of
banks
+ Strengthens regulation, supervision and practices of banks
worldwide with the purpose of enhancing financial stability
+ Basel’s accords enacted by respective governing authorities
(ex. Basel III enforced by U.S. regulatory bodies)
+ Accounting experts group advises BCBS on accounting matters
and has significant influence on standard setting bodies,
especially in Europe
What is the Basel Committee on Banking
Supervision (BCBS)?
International United States
International
Accounting Standards
Board (IASB)
Financial Accounting
Standards Board
(FASB)
IFRS 9 CECL
Basel Committee on
Banking Supervision
(BCBS)
European and other
regulators
United States
regulators
Feedback
Feedback
What document did they release?
“The objective of this paper is to set out
supervisory requirements on sound credit
risk practices associated with the
implementation and ongoing application of
expected credit loss (ECL) accounting
models.”
What is the document’s purpose?
+ “The requirements described in the main section of this paper
are equally applicable under all accounting
frameworks.”…(inclusive of GAAP)
+ “Representatives of IASB provided opportunity to comment on
document but have not identified any aspects preventing bank
from meeting impairment requirements of IFRS 9.”
+ Sets baseline expectations for both regulators & auditors
+ Next “piece of the puzzle” on expectations for CECL
Why should I care?
+ First significant guidance on expectations for
implementation of expected loss model
+ Sets the tone
+ BCBS guidance is very influential for US regulators,
who participate significantly in drafting BCBS guidance
+ Also influential to auditors looking for standards by
which to evaluate client processes
Principles underlying the document
+ Link to full document to be sent out following today’s
webinar
+ 39 pages
+ Summary of principles to ensue
Supervisory requirements for sound credit risk practices
that interact with expected credit loss measurement
1) Ensure institution has/follows
sound credit risk practices
2) Have/document sound process
to measure credit risk
3) Appropriately group exposures
with shared credit risk
4) ALLL should be “adequate”
1) D
2) D
3) D
4) d
5) Model validation
6) Consider reasonable and
supportable processes
7) Credit risk assessments should
be consistent across organization
8) Public reports promote
transparency
Supervisory Evaluation
9) Evaluate credit risk
. practices
10) ALLL
methodology
produces robust result
11) Consider credit risk
practices upon assessing
capital adequacy
Principles underlying the document
+ Principle 1:
+ A bank’s board of directors (or equivalent) and senior management
are responsible for ensuring that the bank has appropriate credit
risk practices, including effective internal controls, commensurate
with the size, nature and complexity of its lending exposures to
consistently determine allowances in accordance with the bank’s
stated policies and procedures, the applicable accounting
framework and relevant supervisory guidance.
Principles underlying the document
+ Principle 1 - Interpretation:
+ Board of directors and senior management are responsible for
sound credit risk practices
+ Responsible for appropriate ECL estimates
+ Ensure effectiveness of internal control system for measuring
credit risk
+ Get board to approve and regularly review credit risk management
strategy – senior management then implements
+ Evaluations of credit risk should be consistent across the
organization for similar credits/forecasts
Principles underlying the document
+ Principle 2:
+ A bank should adopt, document and adhere to sound
methodologies that address policies, procedures and controls for
assessing and measuring the level of credit risk on all lending
exposures. The robust and timely measurement of allowances
should build upon those methodologies.
Principles underlying the document
+ Principle 2 - Interpretation:
+ Banks must have sound methodology for assessing credit
risk
+ Forward-looking information will be required:
+ “Include criteria to duly consider the impact of forward-looking
information and macroeconomic factors.”
+ Consider relevant internal and external factors that may affect ECL
estimates (Ex. underwriting standards and industry, geographical,
economic and political factors)
+ Model validation is key:
+ Backtesting
+ Assess that appropriate economic factors considered in forecasts
+ Models produce reasonable result
Principles underlying the document
+ Principle 3:
+ A bank should have a process in place to appropriately group
lending exposures on the basis of shared credit risk characteristics.
Principles underlying the document
+ Principle 3 - Interpretation:
+ An effective risk rating methodology should incorporate all
pertinent forward-looking/macroeconomic factors
+ Consistency in credit risk evaluations throughout institution
+ Groups of lending exposures into portfolios with shared credit risk
characteristics must be re-evaluated regularly (including re-
segmentation upon relevant new information)
+ Objective tests to validate groupings?
+ Will banks have enough data points to validate groupings empirically?
+ Portfolio as a whole should migrate to a higher credit risk rating if
level of credit risk assessed to have increased on a group basis
Principles underlying the document
+ Principle 4:
+ A bank’s aggregate amount of allowances, regardless of
whether allowance components are determined on a
collective or an individual basis, should be adequate as
defined by the Basel Core Principles, which is an amount
understood to be consistent with the objectives of the
relevant accounting requirements.
Principles underlying the document
+ Principle 4 - Interpretation:
+ Adequate, as defined by Basel Core Principles
+ Robust methodologies to calculate ECL should consider full
spectrum of reasonable information and different potential
scenarios
+ Pooling guidance:
+ Pool based on shared credit risk characteristics
+ Guidance suggests should pool as many loans as you can, as
long as their credit risk is similarly responsive to changes in
forward-looking economic factors
+ FASB: If you can pool, you must
+ Do not rely on biased or overly optimistic judgments
Principles underlying the document
+ Principle 5:
+ A bank should have policies and procedures in place to
appropriately validate its internal credit risk assessment
models.
Principles underlying the document
+ Principle 5 - Interpretation:
+ Given the additional complexities and
introduction of judgment for forward-looking
criteria, model validation ever more important
+ Should be conducted annually at a minimum
+ Should be done by independent third party
+ OCC 2011-12: Supervisory Guidance on Model Risk
Management
Principles underlying the document
+ Principle 5 – Interpretation (cont’d):
+ Elements of sound model risk management program:
+ Governance
+ Clear roles & responsibilities
+ Validation scope & methodology
+ Model inputs
+ Model design
+ Model output & performance
+ Documentation
+ Independent review
Principles underlying the document
+ Principle 6:
+ A bank’s use of experienced credit judgment, especially in
the robust consideration of forward-looking information
that is reasonably available and macroeconomic factors, is
essential to the assessment and measurement of expected
credit losses.
Principles underlying the document
+ Principle 6 - Interpretation:
+ The Committee recognizes that incorporating forward-
looking information and macroeconomic factors into the
estimate of ECLs is challenging, costly and requires
significant judgment. However, the consideration of
forward-looking information and macroeconomic factors is
critical to a robust implementation of an ECL model.
+ “The associated costs should not be avoided on the basis that they are
excessive or unnecessary”
+ Institution’s experienced credit judgment must bridge the gap where
formal statistical information and credit risk cannot be linked
+ Will you have to defend what you did not consider to reach your
estimate?
Principles underlying the document
+ Principle 7:
+ A bank should have a sound credit risk assessment and
measurement process that provides it with a strong basis
for common systems, tools and data to assess and price
credit risk, and account for expected credit losses.
Principles underlying the document
+ Principle 7 - Interpretation:
+ Implement processes, systems and tools to strengthen
reliability and consistency across institution and increase
transparency of ECL estimates
+ Data is key
+ Document transition to ECL, document any changes to
model thereafter
+ Migration analysis can be useful in tying ALLL to credit risk
+ Incorporates view of how credits migrate through various risk levels
Principles underlying the document
+ Principle 8:
+ A bank’s public reporting should promote transparency and
comparability by providing timely, relevant and decision-useful
information
Principles underlying the document
+ Principle 8 - Interpretation:
+ “Additional disclosures may be needed to depict a bank’s exposure to
credit risk, including its ECL estimates, and to provide relevant
information on a bank’s underwriting practices.”
+ Improve disclosures to accommodate for changes
+ How groupings are determined
+ Methodologies used to measure ECL by grouping
+ Forward-looking information & macroeconomic factors considered (and
their impact)
+ Reconcile ECL for accounting and capital adequacy purposes
+ How the process incorporates management`s experienced credit judgment
Risk Management Maturity Model
Source: Managing Financial Risks Strategically In Light of Emerging Regulation, Ridgway & Bayer
Risk Management Maturity Model
Source: Managing Financial Risks Strategically In Light of Emerging Regulation, Ridgway & Bayer
Source: Managing Financial Risks Strategically In Light of Emerging Regulation, Ridgway & Bayer
Key takeaways
+ Integrating credit risk to the ALLL
+ Multiple scenarios important under ECL
+ Model validation
+ Automation can assist in reliability, consistency and
transparency
+ Data
+ Be aware of and don’t spare costs
+ Consistency of credit risk evaluation throughout organization
+ Documenting bases for:
+ Loan groupings
+ Decisions on forecasts
+ ALLL assumptions
+ Foundation is strong credit risk practices
Contact Information
Graham Dyer
Senior Manager – Financial Services
Grant Thornton
Graham.dyer@us.gt.com
Emily Bogan
Senior Risk Management Consultant
Sageworks
Emily.bogan@sageworks.com
Resources
+ The destination website for the ALLL calculation
+ Latest news, peer discussions, industry expert opinions
+ ALLL Forum for Bankers
+ Commercial Credit Risk Professionals
+ www.sageworksanalyst.com
+ Whitepapers, webinars, thought leadership
Resources (cont’d)
+ CECL Webinar
+ Fill out form, we’ll email you invite when guidance passed
+ Web.sageworks.com/CECL/
+ Brief survey following webinar: topics for
upcoming webinars? Speaker feedback?
+ 2015 Annual Risk Management Summit (ALLL + ST)
+ Chicago, IL Sept 23 – 25
+ Sageworks.com/Summit
Questions?

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What Basel says about Expected Credit Loss (ECL)

  • 1. WHAT BASEL SAYS ABOUT EXPECTED CREDIT LOSS (ECL) Graham Dyer Sr. Manager – Financial Institutions Grant Thornton Tuesday March 24th, 2015 PRESENTED BY: Emily Bogan Sr. Risk Management Consultant Sageworks
  • 2. Questions + A copy of the slides and webinar recording will be emailed to you following the webinar + To ask a question during the webinar, enter it into the chat box in the GoToWebinar panel on right side of screen: + Brief Q&A held at end of webinar
  • 3. About Sageworks + Financial information company that provides credit and risk management solutions to financial institutions + Data and applications used by thousands of financial institutions and accounting firms across North America + Named to Inc. 500 list of fastest growing privately held companies in the U.S. + Named to Deloitte’s Technology Fast 500 + NC Tech Awards: Excellence in Customer Service
  • 4. About Grant Thornton At Grant Thornton, we provide clear insights and practical solutions, helping you navigate the complexities of today's business landscape. Our financial services is one of Grant Thornton’s largest industry practices and consists of +55 dedicated partners +Over 500 professionals For more than 80 years, we have been serving financial services companies and financial institutions. Nationally, we have worked with +2,200 public and private financial services companies +350 are banking clients The practice is comprised of senior partners who have served in various C-suite executive roles in the industry; while others have served as former bank regulators. This experience enables us to provide a unique, strategic perspective on current industry matters, as well as implement best practices to position leaders for the future. To learn more, visit us at www.grantthornton.com.
  • 5. Who will be speaking? Emily Bogan Sr. Risk Management Consultant Sageworks Graham Dyer Sr. Manager – Financial Institutions Grant Thornton Ed Bayer Vice President Sageworks
  • 6. Learning Objectives + What is the Basel Committee on Banking Supervision (BCBS)? + What document did they release? + What is the document’s purpose? + Why should I care? + Principles underlying the document + Risk management maturity model + Key takeaways + Conclusion
  • 7. What is the Basel Committee on Banking Supervision (BCBS)? + Basel Committee on Banking Supervision (BCBS) + Primary global standard-setter for the prudential regulation of banks + Strengthens regulation, supervision and practices of banks worldwide with the purpose of enhancing financial stability + Basel’s accords enacted by respective governing authorities (ex. Basel III enforced by U.S. regulatory bodies) + Accounting experts group advises BCBS on accounting matters and has significant influence on standard setting bodies, especially in Europe
  • 8. What is the Basel Committee on Banking Supervision (BCBS)? International United States International Accounting Standards Board (IASB) Financial Accounting Standards Board (FASB) IFRS 9 CECL Basel Committee on Banking Supervision (BCBS) European and other regulators United States regulators Feedback Feedback
  • 9. What document did they release? “The objective of this paper is to set out supervisory requirements on sound credit risk practices associated with the implementation and ongoing application of expected credit loss (ECL) accounting models.”
  • 10. What is the document’s purpose? + “The requirements described in the main section of this paper are equally applicable under all accounting frameworks.”…(inclusive of GAAP) + “Representatives of IASB provided opportunity to comment on document but have not identified any aspects preventing bank from meeting impairment requirements of IFRS 9.” + Sets baseline expectations for both regulators & auditors + Next “piece of the puzzle” on expectations for CECL
  • 11. Why should I care? + First significant guidance on expectations for implementation of expected loss model + Sets the tone + BCBS guidance is very influential for US regulators, who participate significantly in drafting BCBS guidance + Also influential to auditors looking for standards by which to evaluate client processes
  • 12. Principles underlying the document + Link to full document to be sent out following today’s webinar + 39 pages + Summary of principles to ensue
  • 13. Supervisory requirements for sound credit risk practices that interact with expected credit loss measurement 1) Ensure institution has/follows sound credit risk practices 2) Have/document sound process to measure credit risk 3) Appropriately group exposures with shared credit risk 4) ALLL should be “adequate” 1) D 2) D 3) D 4) d 5) Model validation 6) Consider reasonable and supportable processes 7) Credit risk assessments should be consistent across organization 8) Public reports promote transparency Supervisory Evaluation 9) Evaluate credit risk . practices 10) ALLL methodology produces robust result 11) Consider credit risk practices upon assessing capital adequacy
  • 14. Principles underlying the document + Principle 1: + A bank’s board of directors (or equivalent) and senior management are responsible for ensuring that the bank has appropriate credit risk practices, including effective internal controls, commensurate with the size, nature and complexity of its lending exposures to consistently determine allowances in accordance with the bank’s stated policies and procedures, the applicable accounting framework and relevant supervisory guidance.
  • 15. Principles underlying the document + Principle 1 - Interpretation: + Board of directors and senior management are responsible for sound credit risk practices + Responsible for appropriate ECL estimates + Ensure effectiveness of internal control system for measuring credit risk + Get board to approve and regularly review credit risk management strategy – senior management then implements + Evaluations of credit risk should be consistent across the organization for similar credits/forecasts
  • 16. Principles underlying the document + Principle 2: + A bank should adopt, document and adhere to sound methodologies that address policies, procedures and controls for assessing and measuring the level of credit risk on all lending exposures. The robust and timely measurement of allowances should build upon those methodologies.
  • 17. Principles underlying the document + Principle 2 - Interpretation: + Banks must have sound methodology for assessing credit risk + Forward-looking information will be required: + “Include criteria to duly consider the impact of forward-looking information and macroeconomic factors.” + Consider relevant internal and external factors that may affect ECL estimates (Ex. underwriting standards and industry, geographical, economic and political factors) + Model validation is key: + Backtesting + Assess that appropriate economic factors considered in forecasts + Models produce reasonable result
  • 18. Principles underlying the document + Principle 3: + A bank should have a process in place to appropriately group lending exposures on the basis of shared credit risk characteristics.
  • 19. Principles underlying the document + Principle 3 - Interpretation: + An effective risk rating methodology should incorporate all pertinent forward-looking/macroeconomic factors + Consistency in credit risk evaluations throughout institution + Groups of lending exposures into portfolios with shared credit risk characteristics must be re-evaluated regularly (including re- segmentation upon relevant new information) + Objective tests to validate groupings? + Will banks have enough data points to validate groupings empirically? + Portfolio as a whole should migrate to a higher credit risk rating if level of credit risk assessed to have increased on a group basis
  • 20. Principles underlying the document + Principle 4: + A bank’s aggregate amount of allowances, regardless of whether allowance components are determined on a collective or an individual basis, should be adequate as defined by the Basel Core Principles, which is an amount understood to be consistent with the objectives of the relevant accounting requirements.
  • 21. Principles underlying the document + Principle 4 - Interpretation: + Adequate, as defined by Basel Core Principles + Robust methodologies to calculate ECL should consider full spectrum of reasonable information and different potential scenarios + Pooling guidance: + Pool based on shared credit risk characteristics + Guidance suggests should pool as many loans as you can, as long as their credit risk is similarly responsive to changes in forward-looking economic factors + FASB: If you can pool, you must + Do not rely on biased or overly optimistic judgments
  • 22. Principles underlying the document + Principle 5: + A bank should have policies and procedures in place to appropriately validate its internal credit risk assessment models.
  • 23. Principles underlying the document + Principle 5 - Interpretation: + Given the additional complexities and introduction of judgment for forward-looking criteria, model validation ever more important + Should be conducted annually at a minimum + Should be done by independent third party + OCC 2011-12: Supervisory Guidance on Model Risk Management
  • 24. Principles underlying the document + Principle 5 – Interpretation (cont’d): + Elements of sound model risk management program: + Governance + Clear roles & responsibilities + Validation scope & methodology + Model inputs + Model design + Model output & performance + Documentation + Independent review
  • 25. Principles underlying the document + Principle 6: + A bank’s use of experienced credit judgment, especially in the robust consideration of forward-looking information that is reasonably available and macroeconomic factors, is essential to the assessment and measurement of expected credit losses.
  • 26. Principles underlying the document + Principle 6 - Interpretation: + The Committee recognizes that incorporating forward- looking information and macroeconomic factors into the estimate of ECLs is challenging, costly and requires significant judgment. However, the consideration of forward-looking information and macroeconomic factors is critical to a robust implementation of an ECL model. + “The associated costs should not be avoided on the basis that they are excessive or unnecessary” + Institution’s experienced credit judgment must bridge the gap where formal statistical information and credit risk cannot be linked + Will you have to defend what you did not consider to reach your estimate?
  • 27. Principles underlying the document + Principle 7: + A bank should have a sound credit risk assessment and measurement process that provides it with a strong basis for common systems, tools and data to assess and price credit risk, and account for expected credit losses.
  • 28. Principles underlying the document + Principle 7 - Interpretation: + Implement processes, systems and tools to strengthen reliability and consistency across institution and increase transparency of ECL estimates + Data is key + Document transition to ECL, document any changes to model thereafter + Migration analysis can be useful in tying ALLL to credit risk + Incorporates view of how credits migrate through various risk levels
  • 29. Principles underlying the document + Principle 8: + A bank’s public reporting should promote transparency and comparability by providing timely, relevant and decision-useful information
  • 30. Principles underlying the document + Principle 8 - Interpretation: + “Additional disclosures may be needed to depict a bank’s exposure to credit risk, including its ECL estimates, and to provide relevant information on a bank’s underwriting practices.” + Improve disclosures to accommodate for changes + How groupings are determined + Methodologies used to measure ECL by grouping + Forward-looking information & macroeconomic factors considered (and their impact) + Reconcile ECL for accounting and capital adequacy purposes + How the process incorporates management`s experienced credit judgment
  • 31. Risk Management Maturity Model Source: Managing Financial Risks Strategically In Light of Emerging Regulation, Ridgway & Bayer
  • 32. Risk Management Maturity Model Source: Managing Financial Risks Strategically In Light of Emerging Regulation, Ridgway & Bayer Source: Managing Financial Risks Strategically In Light of Emerging Regulation, Ridgway & Bayer
  • 33. Key takeaways + Integrating credit risk to the ALLL + Multiple scenarios important under ECL + Model validation + Automation can assist in reliability, consistency and transparency + Data + Be aware of and don’t spare costs + Consistency of credit risk evaluation throughout organization + Documenting bases for: + Loan groupings + Decisions on forecasts + ALLL assumptions + Foundation is strong credit risk practices
  • 34. Contact Information Graham Dyer Senior Manager – Financial Services Grant Thornton Graham.dyer@us.gt.com Emily Bogan Senior Risk Management Consultant Sageworks Emily.bogan@sageworks.com
  • 35. Resources + The destination website for the ALLL calculation + Latest news, peer discussions, industry expert opinions + ALLL Forum for Bankers + Commercial Credit Risk Professionals + www.sageworksanalyst.com + Whitepapers, webinars, thought leadership
  • 36. Resources (cont’d) + CECL Webinar + Fill out form, we’ll email you invite when guidance passed + Web.sageworks.com/CECL/ + Brief survey following webinar: topics for upcoming webinars? Speaker feedback? + 2015 Annual Risk Management Summit (ALLL + ST) + Chicago, IL Sept 23 – 25 + Sageworks.com/Summit