Perspectives / Dear CEO. COVID lending practices
On the 4th December 2020, the European Central Bank issued a directive to all significant institution CEO’s to provide additional guidance on the identification and measurement of credit risk in the context of the COVID-19 pandemic. The directive provides six specific action points for organisations regarding contract recognition, assessments of borrowers likelihood to default, timely and proactive management of increases in credit risk, appropriate levels of credit provisions and to ensure robust oversight of the credit risk management process.
The letter actively details using alternative methods, alternative data sources and proactive detection of changing credit profiles explicitly stating that the “wait and see” approach is inadequate.
The partner solutions that we provide for Financial Institutions across Europe allow a fast and effective way to address the key points raised by the ECB.
Read our response to the letter and understand how we can help you improve lending practices with the latest technology and operating model enhancements.
ECB Request: Enhanced Procedures
” Significant institutions should ensure that they have enhanced their procedures so that all contract modifications that qualify as concessions and are provided to distressed borrowers, in line with Article 47b of Regulation (EU) No 575/2013 (the Capital Requirements Regulation, CRR) 2 , are correctly classified as “forborne” in their systems. For credit facilities subject to modifications that do not meet the criteria for general payment moratoria laid down in the EBA guidelines on payment moratoria, 3 significant institutions should assess and classify accordingly, on a case-by-case basis, if the modifications satisfy the definition of concession and meet the financial difficulties criteria.”
Contact us to conduct a short, sharp review of the credit and loan systems. This review can also be extended to look at the current loan book and the forborne classification that has been applied, as well as documenting the booking and operating model-related process and procedures, so as to give senior management a sound understanding of the current state, per loan type, and from an end to end booking model perspective.
ECB Request: Regular Assessments & Early Warnings
” Significant institutions are expected to perform a regular assessment of borrowers’ unlikeliness to pay, including exposures with general payment moratoria, using all relevant and available information; when the assessments are performed manually, banks are expected to follow a risk-based approach. Significant institutions should ensure they have enhanced their existing processes, indicators and triggers so that they are appropriate for the current risk environment. Similarly, significant institutions should also ensure their early warning systems are effective. ”
Quantexa allows our clients to be able to join-up more near-time data sources in order to get insight into new behavioural patterns and growing exposure. In addition, the solution can provide contextual analysis of counterparties, offering a platform that enables banks to effectively join internal and external data sources, thereby allowing for a more complete customer view, a more in-depth approach to the standard credit assessment and near real-time updates, removing the need for labour intensive, manual review cycles. This approach, when combined with non-financial data sources (e.g. foot-fall, transport usage, energy usage) provides a deeper context into the customer, significantly enhancing the early warning approaches already in place.
ECB Request: Be Proactive. Do not ”wait and see”
” From a risk management perspective and in order to set appropriate provisions for prudential purposes, the ECB is of the view that significant institutions should identify and record any significant increase in credit risk at an early stage.
Significant institutions should not rely solely on days past due as a trigger for a significant increase in credit risk. In addition, practices such as setting targeted amounts of stage transfers or using reverse engineering to achieve targets should not be used. ”
Quantexa enables Financial Institutions to be able to deep dive at scale on client data, relationships and transactions. The solution removes the labour intensive credit review activity, provides a more complete set of data and ensures Financial Institutions are able to proactively respond to the huge volume of COVID related lending that they are now faced with reviewing and managing. Implement a risk-based scoring approach, reducing workload, improving focus and driving priority with exception-based reviews.
ECB Request: Correctly Estimate Provisions
” The ECB considers it essential that significant institutions correctly estimate their provisions using realistic parameters and assumptions which are appropriate for the current environment. In this regard, significant institutions are recommended to continue anchoring their IFRS 9 baseline scenarios using the ECB’s forecasts in an unbiased manner.
At the same time, significant institutions should not rely solely on through-the-cycle approaches or long-term averages but should instead consider incorporating reliable macroeconomic forecasts (if these are available) for specific years. Significant institutions should ensure that overlays are directionally consistent with macroeconomic scenarios based on verifiable evidence. ”
By using Quantexa to undertake a 360-degree review of the client, Financial Institutions are better positioned to be able to provide a more accurate and demonstratable approach to provisioning. Quantexa can also be used to identify the levels of suspected fraud in the portfolio, something that will become key when dealing with COVID lending-related bad debt.
ECB Request: Ensure Adequate Oversight
” The ECB expects the management bodies of significant institutions to exercise adequate oversight over the critical elements of credit risk management. In addition, significant institutions should also ensure there is segregation of duties across loan origination, risk monitoring and the collection and restructuring processes, as well as adequate internal and external reporting of the relief measures. In addition, the internal audit and internal control functions are expected to perform adequate assessment and monitoring activities in respect of the processes which have been amended in the wake of the pandemic. ”
Following on from the initial process and operating model review, and with the implementation of Quantexa, we are able to provide a revised operating model that focuses on improved oversight, real-time credit reviews, contextual lending and continuous credit checking. We couple these reviews with our ‘Future of Risk’ methodology, that aims to revolutionise the way credit risk in managed within Financial Institutions.
Following on from the initial process and operating model review, and with the implementation of Quantexa, we are able to provide a revised operating model that focuses on improved oversight, real-time credit reviews, contextual lending and continuous credit checking. We couple these reviews with our Future of Risk vision (target architectures, processes, skill sets and operating model) that revolutionises the way credit risk is managed within Financial Institutions.