IFRS9 accounting rules will significantly impact credit providers by requiring earlier recognition of lifetime losses, negatively impacting returns. Consumer credit and SME products will be most affected due to their long duration, high risk/return profiles, and rapid credit quality changes. Lenders must understand the portfolio impacts, analyze response options like interpretating rules and tactical/strategic changes, prioritize responses balancing various factors, and implement initiatives to mitigate unprofitable segments. Early action allows optimizing the response ahead of competitors.

1. THE STRATEGIC IMPLICATIONS OF IFRS9

2. © Oliver Wyman 1
Executive summary
IFRS9 accounting rules will fundamentally change the level and dynamics
of credit provisions, resulting in significantly diminished returns for some
lending products. With the 2018 implementation deadline approaching,
many have been focussed on ensuring compliance with the standard;
attention is now turning to understanding and mitigating the impacts.
IFRS9 requires lenders to fair value lifetime losses when credit quality
deteriorates, however it does not allow for future revenues to be
crystallised along the same timeframe. This creates a costly accounting
“mismatch”; lenders’ capital is depleted by future losses, but not reinforced
by future profits.
At an aggregate level, the earlier recognition of losses negatively impacts
faster growing portfolios. At the segment level, the segments most
materially impacted will be those that have long duration (including
revolving products), high risk and return levels, and rapidly observable
credit quality changes. Given this, consumer credit and SME products will
be disproportionately affected.
The competitive and industry-level impact of IFRS9 will take some time to
appear. However, those who develop their responses early will be better
placed to optimise their actions and response timing, as well as trade-off
customer and financial impacts. Management of the business response to
IFRS9 is set to be a key competitive differentiator for consumer credit
providers over the coming years.
This paper examines how IFRS9 impacts profitability, where the effects
are most material, and how lenders can respond.
The unmitigated impact of
IFRS9 on consumer and
SME credit economics is
significant; lenders must
respond decisively.

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Why does IFRS9 impact product economics?
IFRS9 does not impact the cash flows between lenders and their
customers directly, so could be regarded as having limited impact.
However, it has a material impact on shareholder returns through two
mechanisms. Firstly, it delays the recognition of profits and therefore the
cash available for shareholder dividends and/or capital for growth.
Secondly, it drives higher credit loss provisions, which lead to higher
capital requirements, and therefore reduces economic returns1
.
IFRS9 was formulated to prevent lenders overstating profits early in a
loan’s life and ensure that likely future losses are accounted for promptly.
This is achieved by recognising lifetime losses if credit quality
assessments suggest the cost of risk exceeds that assumed in the
customer’s pricing. The philosophy is to supplement the existing “incurred
loss” provisions that are recognised when objective default triggers are
met with “expected loss” provisions that reflect the future losses.
IFRS9 rules categorise loans into three stages based on their performance
since origination and lenders must hold different levels of provisions
against assets in each stage as shown below in Figure 1.
Figure 1: Overview of IFRS9 impact by stage
Almost all portfolios will have higher provisions under IFRS9, with the
quantitative impact depending on the characteristics of the loans.
1
IFRS9 will generally increase the volatility of profit and loss as provisions are linked to
macro-economic forecasts. This additional economic cost is not the subject of this paper
IAS39 IFRS9 Impact
IBNR
Provisions held against all
performing loans equal to
expected credit losses during
an “emergence period”
(typically less than 12 months)
Stage 1:
Performing
Loans performing as envisaged at
origination carry a provision equal
to 12 months expected credit losses
Stage 2:
Significantly
deteriorated
Loans with a significant increase in
credit risk compared to that
envisaged at origination carry a
provision equal to lifetime expected
credit losses
Impaired
Specific provisions held
against impaired loans equal to
best estimate of credit losses
Stage 3:
Impaired
Specific provisions held against
impaired loans equal to expected
credit losses
IFRS9 requires lenders to
hold higher provisions than
IAS39, negatively
impacting the NPV of
lending products.

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Which portfolios are most affected?
The characteristics of portfolios and segments more impacted by IFRS9
include:
• High risk and return: As IFRS9 recognises losses before revenue
(particularly for loans in Stage 2), higher pricing cannot offset higher
risk until the loan matures
• Long duration: Facilities in Stage 2 hold provisions over their
remaining lifetime, thus products with longer maturities will have a
higher provision. For revolving products, if the behavioural lifetime is
used this can lead to long maturities
• Fast growth: Profits are delayed under IFRS9 and more recent
vintages generally have higher provisions, therefore fast growing
portfolios will appear less profitable in aggregate
• Granular and timely measurement: The timeliness with which
accounts move to Stage 2 is driven by the lender’s measurement
approach. Accounts with behavioural scoring are more likely to be
transferred rapidly to Stage 2 than accounts which only undergo an
annual review
• Non-standard behaviour: Stage 2 provisions are applied to
customers whose behaviour indicates credit quality deterioration (e.g.
a tendency to move in/out of delinquency)
• IAS39 approach: Banks with more conservative IAS39 estimates will
see smaller increases
Considering the above, consumer credit and SME products are severely
impacted by IFRS9. We also see large differences within portfolios; at a
large European credit card provider we found portfolio provisions
increased by ~100%, but many exposures experienced increases over
200%. Figure 2 illustrates the impacts of these effects for a typical 7% PD
5yr personal loan portfolio.
Figure 2: Illustration of impact of IFRS9 on typical personal loan portfolio
Illustrative comparison of IAS39 and IFRS9 product economics (by year since origination)
Average provisions held over year
Year 4Year 3 Year 5Year 2Year 1
IAS39 IFRS9
Annual economic profit
(i.e. accounting profit minus cost of capital)
Year 4 Year 5Year 1 Year 3Year 2
Portfolio NPV
NPV
Provision increases
weaken consumer credit
product economics.

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What can lenders do?
Figure 3: A typical IFRS9 mitigation approach
Understand the problem
Areas where IFRS9 has a disproportionate impact can be identified
through economic modelling. A pragmatic approach is to run analysis at a
segment level, splitting the portfolio by dimensions which are known to be
key drivers (customer characteristics, product type, exposure, risk levels,
delinquency/IFRS9 status, etc.). The impact on economic profit of moving
from IAS39 to IFRS9 for each segment can then be calculated; giving
visibility on which segments become materially less profitable (and why).
This analysis requires assumptions to be made about the methodology
and parameterisation of lenders’ IFRS9 calculations, which may not be
finalised until after the 2018 implementation date. Similarly, profitability
under IFRS9 is dependent on macro-economic forecasts; modelling the
“base case” may obscure how segments perform across the cycle. Given
this, the analysis should aim to identify “hot spots” in an analytically
tractable manner, rather than generating (potentially spurious) accuracy.
Analyse the options
Lenders have numerous potential mitigation strategies which can be
categorised into three areas:
• Interpretation: While the overall aim of IFRS9 is clear, a range of
methodological decisions and parameterisation assumptions are open
to interpretation. A literal interpretation of the rules suggests multiple
areas where they could be “gamed” (e.g. altering renewal date T&Cs);
we do not encourage lenders to act on these and would expect internal
and external independent parties to reject the more pernicious of them.
Nevertheless, within the “spirit” of the rules we observe several areas
for reasonable interpretation; armed with an understanding of their
economic impacts, lenders may wish to re-examine these. For
example, Stage 2 triggers based on bureau changes at household (not
individual level) may not be appropriate for all customers.
Prioritise and
implement
Analyse the optionsUnderstand the problem
• Analyse portfolio at a detailed
segment level
• Size impact of IFRS9 on
provisions, profit and RoE
• Identify hot-spots within the
portfolio
• Develop range of possible
management action responses
– Interpretation of rules
– Tactical levers
– Strategic levers
• Test and size responses
against identified hot-spots
• Prioritise responses, balancing:
– Policy
– Market positioning
– Economics
– Effort and cost to implement
• Develop initiatives
• Mobilize project teams
Lenders can mitigate some
IFRS9 impacts by
developing responses
which target portfolio “hot
spots”.

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• Tactical levers: A range of operational changes can be applied to
customers without significant market impact. For example reducing
unutilised limits for accounts in Stage 2, increasing collections efforts
for deteriorating customers before they enter Stage 2, or developing
Stage 2 restructuring options (e.g. amortising loan for long behavioural
life credit card customers).
• Strategic levers: We are realistic that tactical levers alone will not lead
all segments to deliver acceptable returns; in these cases, more
radical strategic levers will be required. These levers would include
customer, proposition or business model changes and in many cases
would be easier to apply to new customers than the existing base.
These levers will include simply retreating from certain segments
based on unattractive value/ risk characteristics, different channel and
partner use, products (re)design, pricing and so on.
Figure 4: Illustrative, non-exhaustive, range of possible IFRS9 responses
Prioritise and implement
The sheer number of potential mitigation actions provides a challenge, and
lenders will have to prioritise accordingly. We often observe theoretically
compelling actions failing when considered against practical challenges.
There is a need to balance across multiple dimensions:
• Economics: What are the full economic costs, benefits and risks of the
action? What are potential unintended consequences or risks?
• Change capacity: Does the volume of change required dilute
resources available to approach other opportunities?
• Implementation time: How long before the benefit is captured?
• Values: Is the action in line with corporate values and policies? What is
the impact on customers (i.e. are customers negatively impacted and if
so to what extent)?
Lever Examples
Economic
impact
Customer
impact
Interpretation • Examine predictiveness ofdeterioration flags to eliminate false Stage 2 triggers
• Detailed analysis ofbehavioural life by risk to avoid overstating revolving terms
Tactical • Sell customers athigh risk of entering Stage 2 new product with shorter contractual term
• Early warning system and contactpolicies to prevent at-risk customers entering Stage 2
• Specific restructuring options to mitigate Stage 2 impact(e.g. amortising loans reducing loan duration)
• Reduce limits for high risk customers (with low propensityto cure) on entering Stage 2
• Advance sale of assets entering Stage 2 to debt purchaser (ownership change in Stage 3)
Strategic • Adjust segmentparticipation inline with new RoE (customer,channel,acquisition strategy,etc.)
• At the extreme, consider exiting certain customer segments no longer economicallyviable
• Reprice segments no-longer or less profitable to maintain returns
• Introduce dynamic pricing for high-risk segments (i.e.additional charges when in Stage 2)
• Adjust T&Cs to allow regular re-underwriting (i.e.shortening contractual life)
• Introduce amortizing balance productto shorten term for specific higher risk customers
• Adjust scorecards to better discriminate Stage 2 offenders
• Adapt collections strategybased on likelihood and “time in” Stage 2
Mitigation actions must be
thoroughly assessed and
prioritised. Delivery of
initiatives requires a
coordinated effort across
the organisation.

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• Market positioning: What is the likely response from competitors?
What will be the resulting impact on customer volumes/pricing?
• Strategy: Is the change congruent with the overall strategy of the
lender?
After identifying and prioritising more impactful responses, lenders will
have to mobilise teams from across the organisation to deliver the
necessary changes to products, processes and systems. With the 2018
implementation deadline approaching lenders will need to work quickly.
A key challenge to implementation is organisational complexity. The
required changes rely on a broader set of stakeholders than may have
been involved in IFRS9 compliance efforts. Analysing, testing, prioritising
and implementing changes will require a coordinated effort from the
business, Risk and Finance. As such the technical experts who have been
involved in IFRS9 compliance efforts to date are unlikely to be able to lead
this strategic exercise.
Conclusion
IFRS9 will materially impact lending economics, making some segments
less attractive than today. Given that all lenders are affected, this
represents both a challenge and an opportunity. Those who develop their
responses early and optimise their actions stand a good chance of getting
ahead of the competition.

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ABOUT THE AUTHORS
Geoff Holmes is a Principal in Oliver Wyman’s Financial Services Practice
James Mackintosh is a Partner in Oliver Wyman’s Financial Services Practice
Simon Low is Partner in Oliver Wyman’s Financial Services Practice
Matthew Sebag-Montefiore is a Partner in Oliver Wyman’s Financial Services Practice
www.oliverwyman.com
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