“As a fintech, we need to be fast and responsive to customer demands, while maintaining strong risk management,” said Morten Larsen, head of Business Development at Basisbank, which is based in Copenhagen. “We need to give our risk analysts the maximum flexibility to make changes quickly, not wait in a queue for IT to make changes. In our review of the market, FICO provided the most powerful and flexible solution, and also has the greatest expertise in financial services.”

“Basisbank is seen as a leader in the Danish fintech market,” said Steve Hadaway, general manager for FICO in Europe, the Middle East and Africa. “For tech-savvy players like this, the old generation of lending platforms is too slow and inflexible. The cutting-edge power of FICO Blaze Advisor is perfect to help them grow in a profitable and sustainable fashion.”

FICO Blaze Advisor decision rules management system gives businesses maximum control over high-volume operational decisions. Blaze Advisor provides companies with a scalable solution that delivers unprecedented agility and actionability for smarter business decisions. FICO Blaze Advisor is part of the groundbreaking FICO Decision Management Suite for building and deploying decision management applications.

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Identify impacted areas

Certain products are inherently more affected by the change to IFRS 9. For example, the requirement to hold provisions against not just drawn balances but also undrawn commitments significantly impacts credit card portfolios, as expected credit loss (ECL) calculations must consider what balances will be when they default, not just what they are today. Models that capture this ‘exposure at default’ (EAD) reflect the tension between the customer’s desire to access available credit when under stress, and the FI’s desire and ability and to stop them from doing so.

Desire may be constrained by profitability or customer service considerations. The trade-off between risk and reward shifts under IFRS 9, but certainly does not disappear. Evaluating the new ‘sweet spot’ for profitability and returns will allow FIs to re-align their portfolio mix, pricing and product structure to optimise their financials. Customer service still matters – potentially profitable long-term business may move elsewhere if adverse decisions are taken against them prematurely.

Ability may be constrained by technology, systems or regulations. Developing high-quality IFRS 9 models using a wide range of reliable data, and investing in related infrastructure and technology, are both essential for FIs to apply accurate analytical insights in a timely manner. In some jurisdictions, however, regulations limit the ability of FIs to take responsive adverse actions even where they have the technological wherewithal to do so.

Prioritise volatile segments

Some products are inherently more responsive to changes in economic conditions. In a benign macroeconomic environment, for example, a typical mortgage portfolio might still only attract minimal levels of impairment under IFRS 9, due to the value of the security, after considering forced sale discounts, legal costs and other transaction costs that reduce the net sale proceeds. The requirement to consider a probability-weighted outcome will force the raising of at least some provisions for most segments to reflect the possibility of a sudden deterioration in external conditions, however remote.

Once a downturn becomes more probable, though, provisions can rise quickly. Not only will the probability of default (PD) increase, the ultimate loss given default (LGD) will rise rapidly as well. If the net proceeds of a property sale are expected to fully cover the EAD, then LGD is zero. Once that is no longer the case, LGD becomes non-zero and ECL begins to rise in line accordingly.

The IFRS 9 ‘forward-looking’ framework further amplifies the effects of a deteriorating economic outlook. Provisions take a step-change from a 12-month ECL basis to a lifetime ECL basis when accounts move from ‘Stage 1’ to ‘Stage 2’.

Stage 1 captures most new accounts and other accounts where the credit risk has not ‘increased significantly since initial recognition’. In contrast, Stage 2 accounts fail that test, either because they are more than 30 days past due or because their credit risk has otherwise significantly increased since initial recognition. Note that this can occur either because of individual account behaviour (e.g., delinquency on the mortgage account or other loans) or because of expected macroeconomic conditions (e.g., where the property is in a market that is expected to be adversely affected). The migration from Stage 1 to Stage 2 is especially impactful for accounts with long average remaining lifetimes, such as mortgages.

The multiplier effect of an increasing PD rate, increasing LGD rate and move from 12-month to lifetime ECL basis affects some products more than others. Understanding IFRS 9 impacts across a diverse product portfolio requires tailored models and sufficient planning and analysis time ahead of the compliance deadline.

Clean house, then keep the house clean

Armed with a sound understanding of both the expected and potential impacts of IFRS 9, FIs can begin planning and prioritising actions to manage provision levels.

Some planning and portfolio ‘clean up’ activities are required ahead of the compliance deadline to minimise the capital impact of the transition. Most FIs will take Day 1 impacts through their balance sheets by using retained earnings to ‘pay for’ the increase in provisions. Exact impacts are dependent on the capital regime being followed, but typically lead to a reduction in Core Tier 1 equity that is not offset by risk-weighted asset reductions due to higher provision levels.

Mitigating Day 1 impacts requires balance sheet actions that are feasible, effective and appropriate. These might include targeted asset sales, closure of dormant accounts and reduction of unused credit lines for higher risk accounts. Prioritising collections activities based on their IFRS 9 provision impacts can also improve the balance sheet position and instil strong operational practices ahead of the compliance deadline, when such activities will become ‘business as usual’.

Managing provision and capital levels over time requires ongoing review of portfolio mix, credit strategies across the lifecycle, and product pricing and design.

Extend the invite list

IFRS 9 is already a complex initiative involving numerous stakeholders across Risk, Finance, Accounting, IT, Governance, Financial Reporting and Audit. Given the emphasis on achieving compliance, it is understandable that IFRS 9 programme teams have been kept as focussed as possible, rather than inviting a complete set of stakeholders from the beginning.

That said, business and credit lifecycle management teams need to be made aware of IFRS 9 impairment impacts and drivers now, if they have not been already. They will need time to understand the changes and how IFRS 9 will affect the financial impact of their strategies, plus further time to make the appropriate changes both before and after the change-over date.

Accounting standards do not change overnight – IAS 39 went into effect in January 2005 – so preparing the business for the change should be done thoughtfully… but soon!

David Binder is global IFRS 9 programme lead at analytic software firm FICO. David previously led Barclaycard’s global impairment, capital demand and stress testing team, and worked on behalf of major financial institutions worldwide for US-based financial services consultancies.

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October 26, 2016: As part of its FICO Financial Inclusion Initiative, analytic software firm FICO has announced a strategic partnership with EFL Global to expand credit scoring options for lenders and consumers in markets outside the US. FICO will offer EFL’s psychometric scoring alongside its own credit scoring products in global markets, with the initial focus on Turkey, Russia and Mexico.

“We estimate that more than 3 billion consumers globally could gain access to credit at affordable rates if there were an effective way to assess their ability and willingness to repay loans,” said Jim Wehmann, EVP of Scores at FICO. “EFL has over a decade of experience in research and scoring consumers and small businesses with no credit history in 30 countries. Combining this with FICO’s credit scoring expertise and market reach takes us another step closer to helping people lead better lives, which also can have a positive impact on the economy.”

What is psychometrics

Psychometrics is a scientific means of evaluating a consumer’s stability and willingness to repay their loans based on validated consumer contributed data via a survey process. EFL’s psychometric scoring technology was born out of more than a decade of empirical research, initially at Harvard, and validated by over a billion dollars of lending across the world. In the past five years, EFL’s innovations have expanded the horizon of alternative data for credit decisioning.

“EFL’s pioneering psychometric scoring technology has enabled lenders to disburse loans to worthy consumers and SMEs worldwide,” said DJ DiDonna, cofounder and chief strategy officer at EFL. “FICO and EFL have complementary products and a shared focus on helping consumers and small businesses gain access to credit. We are thrilled that EFL and FICO can work together to help information-scarce households and entrepreneurs gain access to affordable credit.”

FICO’s initiative

The FICO Financial Inclusion Initiative aims to help lenders make affordable credit available to the estimated 3+ billion unbanked and underbanked adults worldwide. These ‘credit invisibles’ benefit from credit scores that leverage multiple data sources to assess credit risk and assist responsible lending.

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October 12, 2016: TBC Bank, a leading universal Georgian bank, has substantially reduced the time needed to make decisions on credit applications, using software from analytic software firm FICO. TBC Bank, which recently installed FICO® Origination Manager 4.5, announced that it has cut credit decisions and disbursement down from a day to 15 minutes.

“In today’s digital world, it’s very important to be agile and to reflect the changes in the market,” said Giorgi Alibegashvili, strategic project manager in TBC Bank. “FICO Origination Manager is giving us a competitive advantage, because we can develop and deploy new functionality very quickly. From changing workflows to plugging in new channels to deploying new strategies, we are moving much faster, which is definitely increasing customer satisfaction in our branches.”

TBC Bank, which serves over 1.7 million customers, wanted the most advanced technological partners to upgrade their IT infrastructure, but that’s not all. “During our selection process, the most important criteria for us were experience and trust,” Alibegashvili reported. “FICO is a highly trustworthy company and, along with their platform, they bring tremendous experience as a credit scoring pioneer.”

TBC Bank has been awarded ‘Best Bank in Georgia’ for 12 of the last 14 years (24 awards in total) from various prestigious international publications such as Global Finance, Euromoney, Banker and EMEA Finance.

“TBC Bank is using advanced technology to pursue its goal of being the biggest bank in Georgia,” said Steve Hadaway, FICO’s general manager for Europe, the Middle East and Africa. “We are working closely with them to bring global best practices in banking to their operation, and help them provide superior customer service.”

FICO® Originations Manager delivers the power to make more precise, value-based decisions at the origination stage, enabling credit grantors to grow more profitable portfolios while managing customer-level risk. Built on a platform using service-oriented architecture principles, it minimises IT dependence and ongoing maintenance requirements.

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September 20, 2016: Analytic software firm FICO announced it is providing the decision management platform for UniCredit’s buddybank, a bank project exclusively designed for smartphones. Scheduled to launch in early 2017 in Italy, buddybank will use the FICO Decision Management Suite to instantly verify customers and manage credit decisions in originations, collections and fraud.

“We evaluated providers that offered systems for each segment of the customer lifecycle, but FICO offers not just products but expertise across the lifecycle,” said Angelo D’Alessandro, buddybank founder at UniCredit. “FICO is a partner that is committed to our goals of providing the best service to our customers, and will help us launch buddybank on time and on budget. FICO’s decision management technology is part of what will make buddybank the most innovative new lifestyle bank.”

UniCredit’s buddybank will offer current accounts, credit/debit cards and contextual and instant personal loans, as well as a 24/7 concierge service, accessible via chat and phone, that can help with everyday tasks such as restaurant reservations, taxi booking and travel planning. UniCredit, a leading European commercial bank operating in 17 countries, is targeting the break-even point within three years. Following the launch in Italy, UniCredit will explore launching buddybank in the United States, and other countries in Europe.

“UniCredit’s buddybank represents the next stage for mobile banking,” said Steve Hadaway, FICO’s general manager for Europe, the Middle East and Africa. “For start-ups like this, having one integrated decision management solution not only enables a quick launch, it provides the best way to make customer-level credit decisions and deliver a superior customer experience.”

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