HOW THE 2017 STRESS TESTS CAN INFORM IFRS 9

As The Bank of England publish their scenarios as part of the 2017 Concurrent Stress Testing (CST), Ben O’Brien, Managing Director, Jaywing looks at how these scenarios can inform IFRS 9.

As organisations move into the full implementation and testing phase with IFRS 9, it will be apparent to many that the core economic response modelling at the heart of stress testing is similar to that involved in IFRS 9 Expected Credit Loss (ECL) estimation.

Ben O’Brien

That’s why, increasingly, institutions are looking to align these two aspects of their business operations. Indeed, the same infrastructure that drives the economically driven factors in lifetime expected loss ought to be implemented for stress scenario loss calculations.

About the 2017 scenarios

The 2017 stress tests, which are aimed at the seven largest lenders, are deemed to be the toughest ever test of resilience, after the Bank of England unveiled extra assessment of their ability to weather certain economic scenarios. Alongside the annual cyclical scenario, the Bank of England is running an additional exploratory scenario, which is intended to represent an important step towards achieving the Bank of England’s vision for stress testing, as set out in 2015. These scenarios are devised by a panel of experts at the Bank of England and comprise of forecasts across a selection of key UK macro-economic variables over a seven-year horizon. 

Using the scenarios to inform IFRS 9

For smaller lenders, without economics departments, we have been advocating the use of the Bank of England’s CST scenarios to inform IFRS 9 economic scenarios ever since the first round of stress tests. This could mean avoiding additional costs associated with purchasing external data sources under the ‘undue cost or effort’ clause within the standards. For larger lenders, these scenarios could be compared with internally developed forecasts as part of the validation process. The base scenario could be leveraged as the foundation for an ‘optimistic’ scenario thereby creating the central estimate that IFRS 9 demands.

Either way, these scenarios come from a highly reputable source and are ‘hot off the press’ making the contained forecasts as informed and up-to-date as you will find anywhere in the UK. This is gold dust to anyone wanting a view of ECLs as part of their IFRS 9 programme.

Supporting resilience of the system as a whole

An important objective of the Bank of England stress testing framework is to support improvement in banks’ own risk management and capital planning capabilities. By strengthening banks’ stress testing and IFRS 9 capabilities, banks’ will be able to better assess potential risks to their business, both as part of the concurrent stress tests and implementing IFRS 9. This should support resilience of individual institutions and the system as a whole.

As The Bank of England publish their scenarios as part of the 2017 Concurrent Stress Testing (CST), Ben O’Brien, Managing Director, Jaywing looks at how these scenarios can inform IFRS 9.

As organisations move into the full implementation and testing phase with IFRS 9, it will be apparent to many that the core economic response modelling at the heart of stress testing is similar to that involved in IFRS 9 Expected Credit Loss (ECL) estimation.

Ben O’Brien

That’s why, increasingly, institutions are looking to align these two aspects of their business operations. Indeed, the same infrastructure that drives the economically driven factors in lifetime expected loss ought to be implemented for stress scenario loss calculations.

About the 2017 scenarios

The 2017 stress tests, which are aimed at the seven largest lenders, are deemed to be the toughest ever test of resilience, after the Bank of England unveiled extra assessment of their ability to weather certain economic scenarios. Alongside the annual cyclical scenario, the Bank of England is running an additional exploratory scenario, which is intended to represent an important step towards achieving the Bank of England’s vision for stress testing, as set out in 2015. These scenarios are devised by a panel of experts at the Bank of England and comprise of forecasts across a selection of key UK macro-economic variables over a seven-year horizon. 

Using the scenarios to inform IFRS 9

For smaller lenders, without economics departments, we have been advocating the use of the Bank of England’s CST scenarios to inform IFRS 9 economic scenarios ever since the first round of stress tests. This could mean avoiding additional costs associated with purchasing external data sources under the ‘undue cost or effort’ clause within the standards. For larger lenders, these scenarios could be compared with internally developed forecasts as part of the validation process. The base scenario could be leveraged as the foundation for an ‘optimistic’ scenario thereby creating the central estimate that IFRS 9 demands.

Either way, these scenarios come from a highly reputable source and are ‘hot off the press’ making the contained forecasts as informed and up-to-date as you will find anywhere in the UK. This is gold dust to anyone wanting a view of ECLs as part of their IFRS 9 programme.

Supporting resilience of the system as a whole

An important objective of the Bank of England stress testing framework is to support improvement in banks’ own risk management and capital planning capabilities. By strengthening banks’ stress testing and IFRS 9 capabilities, banks’ will be able to better assess potential risks to their business, both as part of the concurrent stress tests and implementing IFRS 9. This should support resilience of individual institutions and the system as a whole.