[Column] Benjamin Riley: Why Credit Bureaus Are The Ideal Partner
Financial institutions around the globe are feeling the heat from the introduction of IFRS 9 impairment reporting. Credit Bureaus offer the most effective solution for compliance and harnessing the benefits of Credit Risk Scoring and PD estimation.
2018 has seen the introduction of IFRS 9 in many countries around the world. The Credit Industry has broadly understood and accepted the reasons behind the changes in provisioning and reporting this has brought about. However becoming compliant poses significant challenges to Credit providers. Providers must use valuable resources (personnel and capital) to accurately assess the risk of their credit portfolios. Such assessment requires data, skills and resources that many financial institutions simply do not have. The natural response has been to seek partners to assist in this. There is a danger though that in selecting the wrong partner Credit Providers inadvertently lock themselves out of the benefits can be gained from becoming IFRS 9 compliant.
A question all CEOs and Risk Directors of Financial Institutions must answer is do they wish to simply become IFRS compliant at the lowest possible cost or do they wish to use IFRS compliance as a catalyst for generating value for their business? IFRS compliance is indeed an opportunity for your business. An opportunity to bring Credit Risk Analytics into your business, to understand and manage your risk better and to improve collections, sales and overall profitability. IFRS 9 compliance is mandatory, costs will be incurred. The successful Financial Institution will use this to work with partners who can deliver benefits from the inevitable costs of compliance.
Credit Bureaus with their unrivalled dataset, regulated framework, proven experience of delivering value through Risk Analytics and established IT environments are the ideal partner for IFRS.
This is not the place for a detailed examination of the IFRS 9 rules for calculating Expected Credit Loss (ECL). It is sufficient to note that all Credit contracts must be assessed and provided for even if they are performing perfectly. Hence contracts that previously required no provisioning against will now require such provisioning. The key element of calculating ECL is an assessment of Probability of Default (PD) for each contract. It is here that the challenge in ensuring IFRS compliance lies.
In calculating PD, Financial Institutions may seek to develop internal models. Such models examine the institution’s historical data and map it onto their current credit portfolio. Thus if a current contract has the same characteristics as a past one which had a 10% probability of default, then the 10% PD can be used for the current contract.
This may seem a good solution however it is far from being the best solution suffering from 2 crucial problems:
- Lack of data for robust models: Only the largest Financial Institutions will have sufficient historical data and sample sizes to create viable models. Smaller lenders and new lenders will not be able to create internal models.
- Low Quality Prediction of Default: By only using internal data all other credit commitments of borrowers from other organisations are ignored. This dramatically reduces the predictive power of such internal models. With low confidence in the assessment of portfolio risk it is not possible to use PD scores to carry out value-adding activities.
Therefore by taking an internal approach, Financial Institutions, whilst perhaps gaining IFRS 9 compliance, will not have the most accurate ECL provisioning available and are in effect locking in the costs of compliance without opening the door for any of the benefits.
There is a better approach available though. By working with your local Credit Bureau’s IFRS PD models, Financial Institutions will have access to the most accurate PD default models. These models are based on the largest available sample size, full market-wide data and are highly predictive. Credit Bureaus regularly update these models ensuring they continue to remain the most accurate measure available. Typically there is no need for investment in a technical solution as Financial Institutions and Credit Bureaus are already connected meaning IFRS 9 solutions can be very quickly deployed without costly IT development.
Armed with a Credit Bureau IFRS PD model Financial Institutions can understand the risk of their business and take necessary actions. The benefits of partnering with a Credit Bureau on IFRS are many but below are a selected few:
- Guaranteed Compliance on IFRS 9 provisioning reporting
- Most accurate available IFRS 9 provisioning removes the risk of over providing for bad debts
- Smaller Financial Institutions can become IFRS compliant
- Early warning signs of future non-performing loans available.
- Collections policies can be targeted to produce better results.
- Upselling and cross-selling can be carried out with confidence that the Credit Risk of those clients is understood.
- Cost and time savings – allow the Credit Bureau to automatically calculate your IFRS provisioning