Business

Advancing IFRS 9: Transforming Credit Risk Management through Digitalisation

Published

1 month ago

August 26, 2023

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By Sanjin Bogdan, Head of IFRS at Aryza

Developed to replace the earlier IAS 39, the International Financial Reporting Standard 9 (IFRS 9) is an accounting standard issued by the International Accounting Standards Board (IASB), which introduces more principles-based guidelines to enhance the transparency and relevance of financial reporting. It addresses the classification and measurement of financial instruments, as well as the impairment of financial assets.

It aimed to provide users of financial statements with more relevant and timely information about an entity’s exposure to financial instruments and the associated risks.

Key aspects of IFRS 9 include the classification and measurement of financial instruments, a more forward-looking expected credit loss (ECL) model for assessing impairment of financial assets, and improvements to the hedge accounting requirements to better align accounting with an entity’s risk management activities.

Today, legacy IFRS 9 and credit risk management approaches are ripe for digitalisation to stay up to date with tech developments and its benefits to develop and keep a competitive edge, whilst ensuring supervisory expectations are met.

Financial institutions are conforming

Financial institutions are actively taking steps to align with the modern requirements of IFRS 9, this includes intensifying efforts in real-time data management, advanced monitoring, validations, and timely model development and updates to ensure their accuracy and reliability in rapidly changing environment.

In response to the new IFRS 9 requirements, financial institutions are increasing their technology capabilities and increasingly focusing on scenario analyses to gauge the potential effects of different economic conditions on their portfolios. To manage these changes effectively, institutions must upgrade its technology and systems to handle increased data needs and support, adequate credit risk management and ECL calculations. Strong governance frameworks and internal controls are also being established to guarantee the credibility of these calculations and projections.

Furthermore, financial institutions are collaborating across departments, including finance, risk management, and IT, to ensure a holistic and cohesive approach. Engaging with regulatory bodies and auditors helps maintain alignment with expectations. Through these comprehensive efforts, financial institutions aim to conform to IFRS 9, accurately estimate credit losses, and provide stakeholders with transparent insights into their credit risk taking practises.

Real time Credit risk management is becoming a priority

Efficient up to date monitoring and transparency about credit risks are essential when evaluating the risk and defining the cost of risk under IFRS 9. Internally, but also vis-à-vis regulators such as the ECB, Bafin or the Bank of England. The consequences of non-compliance, lack of early detection and advanced monitoring can be serious.

The pressure on banks and financial institutions to keep an eye on credit risks is growing. Most recently, the ECB has even defined those shortcomings in credit risk management and measurement of exposures to vulnerable sectors as a supervisory priority from 2023 – 2025.

The regulator highlights that banks should effectively remedy structural deficiencies in their credit risk management cycle, from loan origination to risk mitigation and monitoring, and address any deviations from regulatory requirements and supervisory expectations in a timely manner.

Internal processes leading to weak sectoral identification and industrial concentration of clients with increased credit risk are increasingly under supervisory scrutiny. The bottom line proved to be delayed monitoring process which usually depends on obsolete client data and lack of understanding of the potential macro-economic impacts on certain sectors within the portfolios.

IFRS 9 challenges

Recent research found there were several challenges financial institutions faced when it came to IFRS 9 and the cost of risk process. Fifty-five percent of respondents highlighted the number one challenge banks were facing is the number of IFRS 9 models which need to be integrated into the process and the need for frequent changes.

IFRS 9 is predictive and forward-looking, requiring reporting of significant increase in credit risk (SICR) before customers miss a payment, however 22% of research participants shared that there is a lack of sensitivity, such as late stage two recognition and direct movement from stage 1 to stage 3, without or with minimum stage 2 period assignment.

A considerable number of participants also stated both regulatory stress testing, budgeting, and forecasting under IFRS 9 was their main challenges, with 66% considering deploying forecasting, budgeting, and monitoring tools within a IFRS 9 tool to improve process efficiency. Overcoming these challenges often involves collaboration between various departments, investment in technology and data infrastructure, and ongoing training and development of staff to ensure accurate, consistent, and compliant processes.

Transforming the credit risk process

To support the IFRS 9 process, the research also found that 42% of participants used core banking solutions, 57% used specialised systems and 28% used Excel. Banks need to be looking to implement software solutions to provide assessment and cost quantification of credit risks based on reliable and up-to-date facts. By implementing the right software, banks will be able complete real time monitoring directly from the client’s accounting system and transpose it to client risk segmentation and adequate staging, which is necessary for impairment calculation under IFRS 9.

Client cash flow and financial performance must be continuously observed, monitored, and evaluated, meaning there is a need for banks to apply software which provides the classification of clients into the risk stages in real-time and which is traceable back to underlying risk factors and models used within the assessment. This can also mean that, based on real-time monitoring data, the identification of risk is performed continuously in real-time, compared to current quarterly or even yearly monitoring exercises. This is clearly a key requirement as 100% of research participants stated that the availability of real-time client financial data and credit monitoring data would significantly improve their IFRS 9 process. Due to this need, financial institutions need to find software to support real-time data access which provides detailed and seamless monitoring, drives the credit risk model updates, and enables continuous back and stress testing projections, something which can hardly be performed in legacy IFRS 9 systems.

Time is becoming increasingly critical in risk management and early deployed remedial actions are proven to be more effective. The ‘early recognition of impairments’ based on the expected loss is a core component of the regulations under IFRS 9, meaning the real-time updating of client data is therefore playing an increasingly significant role.

IFRS 9 has ushered in a new era of financial transparency, requiring institutions to enhance risk assessment and reporting. Financial entities are adapting through improved data management, collaborative efforts, and software solutions to ensure compliance and effective credit risk management. The real-time data imperative underscores the evolving landscape of accurate financial reporting and early risk recognition. As institutions advance their IFRS 9 processes, they not only meet regulatory demands but also enhancing their ability to provide reliable insights into their financial health and risk exposure, thus securing the long-term business viability and driving profitability via efficient cost of risk management.

Related Topics:digitalisation financial instruments Transforming Credit Risk Management

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Business

How can law firms embrace automation and revolutionise their payments?

Published

17 hours ago

September 28, 2023

editorial

Attributed to: Ed Boal, Head of Legal at Shieldpay

Once again, AI is dominating international headlines. This time, it’s due to a closed-door meeting this month between tech leaders and US senators to discuss the technology’s regulation.

AI and automation isn’t just for the likes of Big Tech. We’re seeing predictive and automated technologies transform almost every sector and the legal industry is no exception. In fact, recent research from HBR Consulting found that 60% of law departments had implemented a legal data analytics tool last year and more than 1 in 4 indicated they were using AI for at least a single use case.

However, adoption isn’t without its challenges. Reticence remains among some and there’s also the danger of ‘transformation fatigue’ slowing real progress. If law firms want to reap the many benefits of automation – including revolutionising their payment processes – these challenges need to be carefully considered and thoughtfully addressed.

An area of great opportunity

Often seen as conservative, the legal industry has been gradually warming up to the idea of automation and technology.

While some pioneering firms have been quick to embrace automation tools, others remain cautious about disrupting their established workflows. As we navigate this landscape, it’s clear that certain areas of legal services are ripe for innovation.

One area is contract management. The process of drafting, reviewing, and managing contracts has traditionally been time-consuming and prone to human errors. Automation can alleviate these pain points by streamlining the entire lifecycle of contracts, from creation to renewal, thereby enhancing efficiency and reducing risks.

Another promising domain is legal research. Thanks to advancements in natural language processing and machine learning, legal professionals can now leverage AI-powered research tools that analyse vast volumes of legal data to provide accurate insights and case precedents swiftly.

But, while progress is undoubtedly being made, the legal sector still lags other sectors when it comes to innovation.

What’s getting in the way of progress?

This isn’t always down to a resistance to change. Often, it’s a result of firms spreading their resources too thinly across numerous technology initiatives.

Ed Boal

Attempting to tackle everything at once can result in ‘transformation fatigue’, where the benefits of individual innovations get diluted – leading to frustration and slower progress.

Before legal firms embark on digital transformation projects, a critical first step is introspection. Recognising and acknowledging areas where legacy processes and manual tasks still hold sway is paramount to optimising the impact of automation.

For many firms, archaic practices continue to consume valuable time and resources, diverting attention from higher value, billable tasks. One often-overlooked area is payments.

Legal firms play a critical role in complex transactions, from M&A and real estate deals to litigation and arbitration payments. The associated admin and processes represent a drain of firms’ time and resources. Spanning everything from collating stakeholder payment details and verifying payee identity to ensuring compliance with Know Your Customer (KYC) and Anti Money Laundering (AML) regulation, this adds unnecessary stress for lawyers – who would rather dedicate their time and expertise to their clients’ legal needs.

The repercussions of such time-consuming financial processes reverberate throughout the entire organisation. Administrative burden weighs heavily on the team, affecting productivity and ultimately, the bottom line: recent research from Shieldpay, surveying the UK’s Top 100 law firms, found that almost 1 in 3 (32%) say KYC collection and verification checks take 4-9 working days.

At the same time, firms are exposed to significant financial risk which can make handling client funds a costly endeavour. Not only are they penalised with fines if found to be in breach of stringent client account rules but firms are also subject to hefty premiums for Professional Indemnity (PI) insurance. No wonder 73% of all legal professionals and 90% of junior law professionals are concerned about the risks and time costs associated with holding client funds.

Revolutionising payment transactions

In short, manual payment processes are more than just an inconvenience for modern law firms. They can damage relationships with clients – who have come to expect a fast, painless and automated payout experience in a digital world – and impede revenue generation by tying up top talent in an endless cycle of paperwork and (unbillable) admin.

So how can firms take the pain out of legal payments?

Fortunately, new payment technologies have emerged as a formidable ally. Third-party payment providers offering solutions for law firms, such as escrow and paying agent services for specific transactional deals, or more embedded payment solutions such as managed accounts (TPMAs) – i.e. outsourced client account functions – offer secure and instant transactions, while prioritising transparency and automation.

TPMAs operate as an escrow payment service in which the third-party – a licensed external payments partner – receives and disburses funds on behalf of a firm and their client(s).

With advanced encryption ensuring data security, working with a regulated payment partner means legal professionals and their clients can engage in financial transactions with peace of mind – while law firms benefit from improved operational efficiency.

And the advantages don’t stop there. Enhanced transparency builds a sense of confidence and trust, while the elimination of manual data entry and repetitive tasks allows legal professionals to devote more time to legal services and fostering stronger relationships with their clients.

AI and automation has much to offer the legal sector. But its adoption must be carefully planned in order to avoid transformation fatigue that risks stalling progress altogether. With typically shallower pockets than Big Tech giants, it’s important for law firms to focus their efforts on specific areas that could benefit from automation, rather than rush to overhaul their entire way of working, all at once. This controlled phase-out is the key to avoiding adoption frustration, seeing a real impact on profits and productivity and setting firms up for real, lasting change.

Business

In-platform solutions are only a short-term enhancement, but bespoke AI is the future

Published

2 days ago

September 27, 2023

editorial

By Damien Bennett, Global Director, Principal Consultant, Incubeta

If you haven’t heard anyone talking about artificial intelligence (AI) yet, then where have you been? Conversations about AI and its advantages to society have been a key talking point over recent months, with advances being made in the generative AI race and ChatGPT opening a whole plethora of possibilities. Many have highlighted the advantages of AI, but notably it’s ability to create human-like content.

But these discussions have only scratched the surface of what AI is capable of doing. It is for far more than just essay writing, adding Eminem to your rave and photoshopping dogs into pictures.

In marketing, we have been using AI for years, for everything from analyzing customer behaviors to predicting market changes. It’s enabled us to segment customers, forecast sales and provide personalized recommendations, having a huge impact on how our industry works.

It is even, for the more savvy marketers of the world, becoming a key tool in maximizing budget efficiency – which is apt, considering over 70% of CMOs believe they lack sufficient budget to fully execute their 2023 strategy.

Now, as AI becomes more intelligent, the number of efficiencies it can unlock continues to rise. Not only can it help brands get the most out of their available resources and identify any areas of waste, but it can also help highlight new opportunities for growth and maximize the impact of your budget allocation.

The trick, however, is to veer away from the norm of using in-platform solutions with a one-size-fits-all approach and create your own, bespoke solutions that are tailored to your business needs.

Pitfalls of in-platform solutions

In-platform solutions aren’t by any means a bad thing. In fact, built-in AI tools have become increasingly popular, owing to their ease of integration, user-friendly interfaces and minimal set up requirements. They come pre-packaged with the platform, offering the user the ability to leverage AI technologies without the need for in-depth technical expertise or the upfront cost of building a solution from scratch.

However, the streamlined and accessible nature of in-platform AI solutions comes at the expense of complexity and customization. They are designed to serve a broad user base, but for the most part are built using narrow AI solutions with predefined features and workflows.

This makes them great for assisting with common AI tasks, but they lack the flexibility to tailor functionality towards unique business requirements or innovative use cases, limiting the potential efficiencies and cost savings that can be unlocked. Additionally, if a business’ competitors are using the same platform, they are probably using the same AI solution, meaning any strategic advantage gained from these will be reduced.

Bespoke AI solutions, on the other hand, may carry a higher initial investment – but can offer a significantly more attractive ROI over a short amount of time.

Why customized and adapted AI is the key

The difference between bespoke AI and in-platform solutions is similar to that between home cooked food and a microwave meal. Yes, it is more time consuming to prepare, and yes it likely carries more of an upfront cost, but the end result is going to be far more appealing and will carry more long-term value (financially… not nutritionally).

That’s because bespoke solutions, by nature, will have been tailored to address your brands specific needs and challenges. These custom-built tools allow for much greater efficiencies by streamlining workflows across different channels, automating more complex tasks, and providing deeper, more relevant insights.

The increased level of optimization can significantly improve productivity and reduce operational costs over time, offering a higher ROI. The increased flexibility of bespoke AI also allows brands to implement innovative use cases that can significantly differentiate them from their competitors.

The data analyzed can be specifically chosen to match business requirements, as can the outputs of the AI tool, providing a significant advantage when understanding and acting on the insights provided.

Additionally, these tools are, by nature, more scalable. They can be updated, upgraded and expanded as needs change, ensuring they continue delivering value as the business grows. They can also be designed to integrate with any existing IT infrastructure, from CRM systems and databases to marketing platforms and sales tools – leading to more efficient and effective decision-making.

Managing finances with AI

It’s no secret that AI in marketing automation has, and will continue to, revolutionize the way marketing is done. It has a bright, if slightly terrifying, future and can help CMOs to unlock new efficiencies, maximize the impact of their budgets and increase their ROI. And as this technology becomes more advanced, its impact will only increase.

But we already know that…and so does everyone else.

So, in order for businesses to make themselves stand out from the crowd , they must look to fully adopt the power of AI. Creating a customized and unique AI solution could be the way to set yourself apart from your competitors. A bespoke AI tool can provide brands and businesses with features unique to them and their business needs. As a result, companies will benefit from more useful data and better results to make more data-driven decisions for their business. Ultimately, this will help brands to maintain a competitive edge over their competitors, deliver ROI and most importantly optimize their budgets.