Ifrs9 assessment and strategic implications

By Mohammad Ibrahim Fheili
IFRS 9
A Tool For Asset Quality
Measurement & Management

“Deciding what
“not to do” is as
important as
deciding what “to
do”!”
I Will Be Talking About:
What Have We NOT Done?!

Basel II, published in final form in 2006, lays out a three-pillar approach to risk and capital management for
banks.
• Pillar 1 outlines a complex set of definitions, processes, and formulas to calculate minimum regulatory capital
requirements.
• Pillar 2 describes the MANDATORY processes for both banks and regulators to fulfill
the capital adequacy requirements. Banks have to conduct an ICAAP to
DEMONSTRATE that they have implemented methods and procedures to ensure
adequate capital resources, with DUE ATTENTION TO ALL MATERIAL RISK. Regulators
have to conduct a Supervisory Review and Evaluation Process (SREP) to assess the
soundness of a bank’s ICAAP and take any appropriate actions that may be required.
• Pillar 3 mandates the disclosures that banks must make to provide investors and the public with full
transparency.
At the center of most banks’ ICAAP are their Internal Risk Model.
Back To Basics: The 2006 version of Basel Accord

The objective behind Pillar 2 of the Basel Accord is to require Banks to
consider risks which are either:
• not captured at all by Pillar 1, or
• not captured fully by Pillar 1 (e.g., Credit Risk is not captured
fully by Pillar 1).
The aim of the Pillar 2 processes is to enhance the link between:
• An institution's risk profile,
• Its Risk Management, Risk Mitigation Systems, and
• Its Capital Planning.

Pillar 2 can be divided into two major components:
 Aimed at Financial Institutions, where those are expected:
 to establish sound, effective and complete strategies and processes
to assess and maintain, ON AN ONGOING BASIS, the amounts,
types and distribution of internal capital commensurate to their
risk profiles (ICAAP) – risk that is not captured (fully or partly) by
Pillar 1,
 as well as robust governance and internal control arrangements.
 Supervisory Review and Evaluation Process (SREP). The key purpose of SREP is to ensure that institutions have
adequate arrangements, strategies, processes and mechanisms as well as capital and liquidity to ensure a sound
management and coverage of their risks, to which they are or might be exposed, including those revealed by
stress testing and risks institution may pose to the financial system.

and regulatory credibility

 No “Default” Definition – Partially ICAAP.
 No Definition of what constitute a “Significant Deterioration In
Credit Risk Circumstances” - ICAAP.
 Under the Incurred Loss Model, a facility may be performing
(Pillar 1), but you do have information that indicate otherwise
(ICAAP)!
 A “Forward-Looking” Expected Credit Loss – ICAAP. In today’s
Economic and Banking Environments, is the “past” a good
predictor of the “future”?!
 Focus on FI’s ability to “Demonstrate Compliance” - SREP
IFRS 9: The Product Of The Building Blocks Of Pillar 2!

IFRS 9: The Product Of The Building Blocks Of Pillar 2!

Business Growth
Stress Capital
Management Buffer
Components of Internal Capital
Economic Capital
- Internal quantitative & aggregated risk estimates for credit, market & operational risks.
Management & Strategic Buffer. Level of capital that the management deem necessary for:
- acquisitions;
- business and infrastructure investments;
- changes to the legal structure.
Capital for Business Growth
- Individual business functions will be expected to identify how their capital requirements are
anticipated to change over the projected financial year.
Capital for Stress Events and Weakness in Risk Analysis
- Evaluate stress testing analysis and estimate capital requirements to cover extreme events
- Weakness in the methodology and general risk management controls would be subject to
capital requirements
Economic Capital
Supervisory Add-ons
Pillar1 Requirements Components of Regulatory Capital
Minimum Capital Requirements to protect the national banking system from the systemic risk.
Additional Capital deemed appropriate to cover for those risks which are not effectively
addressed by the minimum Pillar 1 based capital requirements.
Capital: Internal & Regulatory which are Two Independent Measures

As Pillar 1 is focused on credit risk, market risk and operational risk, the ICAAP should consider the
following risks to the extent that they are applicable to the Bank and its business model. Key risks
which should be considered as part of an ICAAP include:
Credit risk;Market risk; Operational risk;
 Interest rate risk in the non-trading book;
Concentration risk;
 Funding risk; Liquidity risk;
 Business/strategic risk;
 Reputation risk;
 Conduct of business risk;
 Money laundering risk; Sanctions risks;
 Regulatory risks;
 Any other risks identified by the Firm’s Enterprise Risk Framework.

The ICAAP results in higher capital requirements, for two main reasons:
1. A broader range of risks is covered compared with Pillar 1 definitions, and
2. Banks’ SREP often reveals inadequacies in banks’ risk and capital management that must be covered with
higher charges.
The greater part of Banks’ attention before the economic crisis was focused on compliance with Pillar 1. Recent
regulatory changes to Pillar 1, which constitute the bulk of the Basel III proposals, have only made that focus more
acute.
• A recent McKinsey’s Capital Management Survey found that more
than two-thirds of large banks largely or fully relied on Pillar 1 in
managing their capital position.
• Regulators, too, spent most of their time assessing Pillar 1
implementation.
Back To Basics: Survey Says . . .

 Long History of Regulatory Guidelines.
 No Complete Implementations.
 BoD not equipped to handle much of what is assigned to it!
 Too Much Has Been Dumped on Pillar 1.
 National Supervisory Authorities failed to be the Whip they were
meant to be; instead, they enjoyed the role of Chaperon.
 False Impression that Risk is Centralized!
RealityCheck!

Risk Is Decentralized,and There MUST BE Greater Focus on the First Line of Defense!

The purpose of the Internal Capital Adequacy Assessment Process (ICAAP) is to inform the Board of:
• The ongoing assessment of the bank's risks,
• How the bank intends to mitigate those risks and
• How much current and future capital is necessary having considered other mitigating
factors.
One forward looking aspect of the Internal Capital Adequacy and Assessment Process
(ICAAP) is stress testing of all risk factors in order to arrive at the capital requirements for the worst case
scenario. Stress testing also allows the bank to plan and prepare for unexpected situations that may arise in the future.
Capital Adequacy was the principal message of the Basel II framework. However,
• A static regulator-driven capital adequacy measure was deemed insufficient to manage
the risk profile and capital requirements of an active bank in today’s risk environment
creating the need for an internal and invasive assessment of the capital profile of a bank.

On 24 July 2014, the IASB issued IFRS 9 Financial Instruments:
 This was the final version of the Standard and replaced all previous versions.
 The Standard had a mandatory effective date for annual periods beginning on or
after 1 January 2018, with earlier application permitted.
Why the new standard?
 IFRS 9 replaced IAS 39, Financial Instruments – Recognition and Measurement.
 It was meant to respond to criticisms that IAS 39 is too complex, inconsistent
with the way entities manage their businesses and risks, and defers the
recognition of credit losses on loans and receivables until too late in the credit
cycle.

In preparing for “IFRS 9”, banks dedicated
most of their efforts to the IFRS 9
Calculator; however, little was done to
secure Organizational Readiness for the
years ahead.
IFRS 9 is all about Asset Quality!
The BCC of Lebanon Issued the IFRS 9 11-page
Implementation Circular 293 on 28/12/2017
 Effective Date of compliance is on 1/1/2018 to apply on
balances as of 31/12/2017 balances.

?
?
?
?
“Weakness in the methodology and general
risk management controls would be subject
to capital requirements” . . . Pillar 2

Acquisition/
Credit
Specific
Customer
Service
Collect And
Review
Data
Credit
Analysis &
Review
Assess
Collateral
And Risk
Document
Approval
&
Pricing
Financial & Risk Analysis: Understanding Risks Processing
Establishing
Contact
Evaluate first
customer info
Customer
Meetings
Debriefing
Request
documents
Obtain data &
information
Completeness/
plausibility
review
Follow up
Review document
Follow up with
Loan Officer /
Account Manager
Standardized
Credit Rating
Document on
other credit
related factors
Inspect
Object
Determine
Loan-to-value
Evaluate
Exposure
Data is
Sufficient
Complete
Loan
Application
Prepare
Credit rate
Handover
Credit File
Follow Up
Data is
Complete
Approval by
Decision
Makers
Check Compliance with
Authority Structure
Prepare Contracts
Get Signatures
Provide Security
Disbursement Review
Disbursement
Loan/Asset Life Cycle
Credit Approval Process
Implement
On the
Credit
Decision
Portfolio Analysis
When The Topic Is Credit, Credit Risk is not all there is!
Sales: Bank-Client Interface
Target
Market
Monitor &
Report
Resolution

Between IAS 39 Accord and IFRS 9, and the Asset Life Cycle
IAS 39 – Incurred
Loss Model
General / Collective Provisions Specific Provision
Non-Performing
Performing Watch-List
Stage 1
Performing
Assets
EL=PD12-Month x (∑PV
of Cash Shortfalls)IFRS 9: Forward-
Looking Expected
Credit Loss Model Stage 2
Under-Performing
Assets
Stage 3
Non-Performing
Assets
EL=PDLifetime x (∑PV
of Cash Shortfalls)
EL=PDLifetime x (∑PV of
Cash Shortfalls)
Along with other
considerations;
 No “Default” Definition.
 No Definition of what constitute a “Significant Deterioration In Credit Risk
Circumstances”.
 Focus on “Reporting Date”; Your “Best Estimate of EAD”; and “PV of Cash
Shortfalls”
 A “Forward-Looking” Expected Credit Loss. In today’s Economic and Banking
Environments, is the “past” a good predictor of the “future”?!
 Focus on FI’s ability to “Demonstrate Compliance”

Focus 1: Adverse Selection Working on selecting a good Credit
Risk – Target Market
Focus 2: Moral Hazard The proceeds from the loan are being
used for the intended and stated reason?
Focus 3: Timely Settlement Delays in settlement costs money
– i.e., Impairment Provisions, and drains on Liquidity
Acquisition/
Credit
Specific
Customer
Service
Collect And
Review
Data
Credit
Review
Assess
Collateral
And Risk
Document Approval
Sales Financial & Risk Analysis Processing
Asset Life Cycle
Implement
On the
Credit
Decision
Focus 4: Repeat Business If & Only If all of the above went as
planned and as intended; . . .
Spotting Milestones on The Credit Landscape . . .CreditRiskStartsHere

IFRS 9: You Ought To Do It Right From The Start
Deteriorating Credit Risk Circumstances
Moral Hazard …Adverse Selection …
Beware of the
Target Market
Date Of Recognition
IAS 39 – Incurred
Loss Model
Non-Performing
Performing
Watch-List
Stage 1
Performing
Assets
Looking Expected
Under-Performing
Assets
Stage 3
Non-Performing
Assets
of Cash Shortfalls)
Cash Shortfalls)
Along with other
considerations;

 Monitor & Manage every File in the Loan Portfolio
individually, and in Real-Time Live Environment.
 It is THE ONLY way to capture slow (and manageable) or
fast (unmanageable) deterioration in Credit Risk
Circumstances.
IAS 39 – Incurred
Loss Model
General Provision / Collective Provisions
Specific
Provision
Non-
PerformingPerforming Watch-List
Stage 1
EL=PD12-Month x (∑PV of Cash Shortfalls)
IFRS 9: Forward-
Looking Expected
Credit Loss Model
Stage 2
Stage
3
of Cash Shortfalls)
EL=PDLifetime x
(∑(PV of Cash
Shortfalls + . . .)
A. “Adverse Selection” and residency of a
facility in Stage 1 are highly correlated.
IFRS 9: You Ought To Do It Right!

Default.
KRIs
Losses.
KRIs
Drop in the Value
of Assets.
KRIs
In the absence of adequate
cushion (Provisioning and
Tangible Capital) – i.e., - there
will surely be a harm to the
institution.
What Risk Factors may
contribute to an increasing
probability of default
(Stage 3)? . . . Focus is on
Primary Source of
Repayment.
contribute to impairment
of assets backing the loan?
. . . Focus is on Secondary
Source of Repayment
(Collateral)
Asset Life Cycle
Asset Value=∑PV of Cash Flows
… At the heart of IFRS9
Increase in Risk reduces the
present value of Cash Flows.
Spotting Pain Points In The Asset Life Cycle
Delinquency.
KRIs
contribute to delinquency
(stage 1 or 2), and the
severity of delinquency
(stage 2, or 3) in
settlement?
InitialRecognition
Could You Imagine The Benefits from capturing this
data. . . .
This is one sure way
to “Demonstrate”
compliance with
IFRS 9

The IFRS 9 Calculator
The Basic Concept of Time Value of
Money

Solutions:
 ALM
 CAR
 Credit Risk
 ORM, MRM
 CRM
 eBanking
 P & L
 AML
 FATCA
 CRS
 GDPR
 IFRS9
 Etc.
To Interface
With The
Core
Banking
Solution
Each one of these IT Solution is likely to have been developed
by a different IT Solution Provider !!!
Resorting To Ready-Made IT Solutions Is RISKY IF . . .
Core If Yes, Your
undisputed
assurances are
coming form
where?
Data

IAS 39 – Incurred
Loss Model
Non-Performing
Performing
Watch-List
Stage 1
Performing
Assets
Looking Expected
Under-Performing
Assets
Stage 3
Non-Performing
Assets
of Cash Shortfalls)
Cash Shortfalls)
Along with other
considerations;
Back To Basics . . . The IFRS 9 CalculatorMade Simple
Initial Recognition (t0):
 Initial Risk Assessment Leading to Approval and Booking of the Loan.
 Initial Loan Rate can be defined as: R0=r0+DRP0+LRP0+MRP0
 LRP0 is somewhat incorporated in DRP0 & MRP0 since our Banking Model is
such that Loans are Originate-To-Hold; not Originate-To-Sell (i.e.
Securitization).
 MRP0=f(M, Nature of Default, Forward-Looking Component)
The Regulator Was Not
Looking For Rocket
Science In The
Calculation of
Impairment Allowances
based on ECL.

At Time (td):
 Significant deterioration in Credit Risk Circumstances was detected (DRPd)
 The Interest Rate: Rd=r0+DRPd+LRPd+MRPd
 DRPd>DRP0 To reflect the heightened Risk and Rd>R0. Loan is Staged to Stage 2.
 MRPd=f(remaining time to M, Nature of Default, Forward-Looking Component)
 The longer the remaining time to maturity, the worse off the situation is!
 Does this deterioration in Credit Risk Circumstances follow a flat or steep term structure?
 The Present Value of the Loan at td is PVLd = ∑(PV of Cash flows) using Rd . . . PVLd<PVL0 where PVL0 =
∑(PV of Cash flows) calculated at td using R0
 (PVLd - PVL0) is a very good proxy for sizing the Credit Impairment on that facility.
IAS 39 – Incurred
Loss Model
Non-Performing
Performing
Watch-List
Stage 1
Performing
Assets
Looking Expected
Under-Performing
Assets
Stage 3
Non-Performing
Assets
of Cash Shortfalls)
Cash Shortfalls)
Along with other
considerations;
Back To Basics . . . The IFRS 9 CalculatorMade Simple

You Are As Good As Your
Data!
Good Data Strengthens And Improves Your
Ability To Manage Your Assets Real-Time On-
Line (Capture Warning Signals As They Happen!)

MAXIMIZE PROFIT subject to:
RISK , REGULATORY, Compliance,
Reporting, Etc. Constraints
RISK . . .
 Default
 Liquidity
 Maturity
 Others . . .
REGULATORY . . .
 Basel I
 Basel II
 Basel III
 Basel IV (In the making)
 AML & Sanctions Rules
 USA_FATCA, OECD_CRS, EU_GDPR Requirements
 IFRS9 . . .
Uses of Funds Sources of Funds
 Reserves
 Loans
 Securities
 Other
Investments
 . . .
 All Types of
Deposits
 Borrowings
 Other
Sources
 Equity
 . . .
Off-Balance Sheet
Legal Issues . . .
TO Comply
Produce The
Required Report
Collect just enough
Data
The Banking Model. . . Banks Collect Data To Be Used Largely For Compliance Purposes

Credit Approval Process & The Asset Life Cycle Have Changed: Data-Rich,
Information-Intensive.
Quantitative
Evaluation
Qualitative
Evaluation Rating & Staging
Data: Time-Series,
Cross-Sectional
Migration
Matrix
Probability of
Default - PD
Loss Given
Default - LGD
Exposure At
Default - EADCredit Risk
Components
Calculation
Of Credit
Risk
Amount
(Measurement
Model of
Credit Risk)
Stress Testing: Portfolio & Obligor, Forward Looking, . . .
Expected
Loss (EL)
Unexpected
Loss (UL)
(Single Asset
And
Portfolio)
<< Periodic Assessments – Reporting Date >>
< Quantification of Credit Risk >
Portfolio
Monitoring
Provisioning
Pricing
Profit
Management
Capital
Allocation
Rating Migration
Analysis
< Credit Risk DATA >
Earning
Volatility
Must change
with Risk
Provisions for IFRS9
impairment &
Capital
M - Maturity
12-Month
& Lifetime
PD

The Introduction of any form of technology in a given production process (e.g., Credit
Approval Process, Risk Rating, Credit Scoring, IFRS 9 Impairment Calculations, etc.) or the
mere modification of an existing IT environment necessitates a number of changes:
Staff Skills,
Workflows,
Policies & Procedures, and
a host of other changes.
Which will reflect on Performance…
In general, we have the unchallenged tendency to trust
numbers produced by a machine much more than
those voiced by a human (is this a curse or a
blessing?)!
Readiness of Data & Systems. . .

Risks (Intentional &
Unintentional)
Known to The
Financial Institution
. . . With continuous
efforts to Identify
more
Non-Identifiable Risk
Non-IdentifiableRisk
Available Tools For Data
Collection:
• CIP
• KYC
• DD
• EDD
• Complete and Up-To-
Date Credit File,
• Duly Documented
Client Visits.
• Proper Follow Up
• Comprehensive &
Consistent Data about
the Market
• Etc.
Identified &
Identifiable
Risks
Process Automation Boost The Importance Of and the Demand for Complete,
Relevant, Timely, and Good Quality Data.
The more Data you collect, the much more Risks will be
identified, the better Understanding you will have!
Bank
Data
?
Asset
Data
?
Liability
Data
?

Increasing Our Understanding of Potential Outcomes
(i.e., Impact)
IncreasingEvidenceonProbabilityof
occurrence(i.e.,Probability)
Ambiguity
Uncertainty
Ignorance
Well Managed & Processed Data Helps Decision-Makers Move Away From
Ambiguity, Ignorance, & Uncertainty to Proper Sizing of Risk.
Technology Changes
The Way We Do
Things!
IFRS 9 is not ONLY
about Understanding
and Treating Risks,
but about being able
to Demonstrate such
a capacity!

What You Refuse To See, And
Don’t Pay Attention To Could Kill
You!
Probe About The Root Cause Of The Problem!

Consequences:
Losses
Risk
Event:
Loan
Default
a) Dried up Cash Flow Sources: Client’s business
received a bad hit causing dramatic changes in his
business environment.
b) Collaboration between the RM and the Client in the
provision of inflated figures (Sales, Revenues, Cash
Flows, …) leading to a false-favorable credit decision.
c) Over-worked, and Under-Staffed Business Unit
leading to overlooking some critical changes in
Operational Environment of the Client.
d) Incompetent Bank Employee(s) Gave False analysis
and Recommendation which led to a False-favorable
Credit Decision.
e) Poor/Inadequate Follow-up and Reviews rendering
the process weak in capturing “Early Warning
Signals”
f) Etc….. there could be Violations to AML and/or
other Rules
Numbers Are Not Enough! These are Noted [Actual] Causes of Asset Failures.
Possible
Causes
Causes of Default.
a) Credit Risk
b) Ethics & Moral Value
c) Workforce Planning
d) Training & Development
e) Performance Management
f) AML Concerns

 Staff
 Business Unit
 Senior Management
 Board of Directors
Report Risk Events, Collect Data, Report, Etc.
Assess
Control
Oversight
Most
Risks Start Here
Every individual comes to the organization with his/her
own personal Perception of Risk.
Every Person comes to the Organization with
his/her own Inventory of Moral Values and
these have a great influence over the decisions
he/she makes . . .

IFRS 9
Secure Long Term
Organizational Readiness
Revisit the Entire Credit Approval Process,
and Re-Assess your Existing Approach to
Managing the Asset Life Cycle

IFRS 9: Secure Long Term Organizational Readiness
Implications For Portfolio Strategies.
• Revise your credit portfolio allocation and lending policies.
• Reduce lending to volatile sectors with a poorer outlook.
• Weigh the financial duration of portfolios more heavily in your
lending decisions and reduce lending on long-term transactions.
• Focus on collateralized lending portfolios to mitigate Loss Given
Default and reduce lending to unsecured exposures.
• Treat higher-risk clients differently in your lending decisions.
• Scrutinize lending to performing high-risk clients more thoroughly.

Impact On Commercial Policies.
Rethink your product offering.
Adjust your pricing to sustain profitability.
Adjust maturity and amortization to shorten product lifetimes.
Encourage Relationship Managers and Clients to shift to products with
shorter terms or early redemption options.
Raise prices for longer-term and less collateralized products
and for higher-risk clients.
Rethink how any of the above may damage your competitive
position.

Changes To Credit Risk Management.
• Strengthen your monitoring of counterparty and data quality to
prevent increases in ECL.
• Improve your early-warning mechanism to detect any deterioration
in client’s lifetime credit risk.
• Increase your monitoring of collateral data.
• Flag warning signs to your relationship managers to trigger remedial
actions.

Evolution Of Deal Origination.
• Adjust your credit strategy and policies to change the course of new
business development.
• Introduce new risk limits for clients, sectors, or products most
affected by IFRS 9.
• Change our origination process.

Impact On People Management.
• Revise your incentive and compensation schemes for relationship
managers.
• Change RMs’ accountability – ‘Skin In The Game!’
• Change your performance metrics to reflect IFRS9-adjusted
profitability.
• Provide continuous re-training and re-skilling for your RMs on the
consequences & implications of IFRS9 and appropriate remedial
actions.

Revisit Performance Incentives: Jump away from the balance sheet
and find ways to generate traffic (e.g., commissions & charges)

Brilliant Surgery!
Well Done!
Shame the patient
died.
 Descriptive
 Diagnostic
 Predictive
 Prescriptive
IFRS 9 is about
making the
right
IFRS 9 is about
making the
right

 Risk & Capacity Building, and Organizational Transformation
Specialist.
 Lecturer in Risk, Risk-Based Performance & Compliance
 University Lecturer: Economics, Risk, and Banking Operations
 Currently serves in the capacity of Chief Consultant with M.I.Fheili
& Associates – Risk, Capacity Building, and Organizational
Transformation Specialists.
Served as:
 Executive (AGM) at JTB Bank in Lebanon
 Senior Manager & Chief Risk Officer at Group Fransabank
 Senior Manager at BankMed
 An Economist at the Association of Banks in Lebanon
 Mohammad received his college education (undergraduate &
graduate) at Louisiana State University (LSU), and has been
teaching Economics and Finance for over 25 continuous years at
reputable universities in the USA (LSU) and Lebanon (LAU).
 Finally, Mohammad published over 25 articles, of those many are
in refereed Journals (e.g., Journal of Money Laundering & Control;
Journal of Operational Risk; Journal of Law & Economics; etc.) and
Bulletins.”

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