Banks need to be more agile in incorporating in their ECL model all latest reasonable and supportable information, including that which is forward-looking, says Pierre Latrobe.
Hong Kong banks need to review the way they build their scenarios to determine their expected credit losses (ECL) under HKFRS 9, according to a new paper from Mazars.
The paper presents an analysis of the impairment process of 22 banks in Hong Kong, based on the published financial statements as of 31 December 2019.
Although this did not yet account for the impacts of Covid-19, which will be incorporated in the interim and year-end financial statements 2020, credit quality for most of the banks covered in the study had still deteriorated as a result of other factors, including the US-China trade dispute, ongoing social unrest in Hong Kong, and weaker global economic growth.
The study shows an overall shift for the banks of -1.22 basis points of the total gross loans and advances to customers transferred from stage 1 to stage 2 of impairment – which means there has been a significant increase in credit risk of the instrument since its initial recognition.
Still, 18 of the 22 banks mentioned Covid-19 as a non-adjusting post balance sheet date event in the notes to their financial statements, with five banks explicitly expressing that they had performed a stress test or other form of analysis to estimate the impact of the pandemic on their financial resilience.
While the stress test results showed that banks had enough capacity to deal with the potential impact of Covid-19, the paper highlights that the real impact on the economy will only become apparent “after the temporary relief measures have faded”.
“Understandingly, some businesses will fall or will struggle to repay their loans in full in the short to medium term,” it says. “To make matters worse, the scale, the duration and the recovery shape [of the crisis] are still uncertain.”
“To improve the impairment process, the ‘Business as Usual’ (BAU) approach cannot cope with the sharp increase in lending volume, the frequent issuance of new regulatory measures, the extreme market volatility and the significant amount of new information.”
The paper outlines eight areas of immediate focus for banks looking to improve their impairment operating models, from scenario building and modelling, to governance, IT infrastructure and data quality.
“Whilst many see this as a challenge, it should also be seen as an opportunity to improve the impairment process and be more agile and responsive to the external environment,” the paper says.
Given current uncertainties and to reflect the rapid changes in the environment, Hong Kong banks need to be more agile in incorporating in their ECL model all latest reasonable and supportable information, including that which is forward-looking, according to Pierre Latrobe, Director of Financial Services at Mazars Hong Kong and author of the paper.
“Improving the impairment model requires a joint effort from specialists sitting in various departments across the bank such as business, risk, finance, economist, internal audit and IT.”
Banks also need to stay abreast of government announcements regarding supporting measures, as well as the subsequent clarifications issued by supervisory authorities, Latrobe said.
“Indeed, they significantly impact the development of scenarios, scenario re-weightings and risk parameters that are used in determining the ECL.”
The full paper is available here.