Tighten the Noose on Credit Risk, CBN Tells Banks

• Naira continues slide, slumps to N495/$ on parallel market

Obinna Chima

Ahead of the May 2017 implementation of the International Financial Reporting Standards (IFRS) 9, the Central Bank of Nigeria (CBN) has said it expects banks to put in place policies and systems, as well as governance arrangements and controls to identify where their exposure to debtors have suffered a significant increase in credit risk.

The central bank stated this in its “Guidance Note to Banks and Discount Houses on the Implementation of IFRS 9 (Financial Instruments) in Nigeria”, signed by its Director, Banking Supervision, Mrs. Tokunbo Martins, a copy of which was posted on its website yesterday.

The guidance note communicates supervisory expectations for the implementation of the new standards, especially in areas where banks are expected to exercise considerable judgment and/or elect to use simplifications and other practical expedients permitted under the standards.

It also specifies information to be submitted to CBN not later than April 30, 2017 on IFRS 9

Furthermore, it requires banks to submit monthly status updates on the implementation projects starting May 2017.

The IFRS was adopted in the Nigerian banking sector on January 1, 2012 as part of measures to improve reporting practices, transparency and disclosures in the sector.

IFRS 9 prescribes new guidelines for the classification and measurement of financial assets and liabilities, making fundamental changes to the methodology for measuring impairment losses, by replacing the “incurred loss” methodology with a forward-looking “expected loss” model.

The implementation of IFRS 9, especially the expected loss impairment methodology would entail the exercise of considerable judgment by banks.

To this end, the CBN stressed that in assessing significant increases in credit risk, banks are to consider quantitative, qualitative and ‘backstop’ (30 days past due presumption) indicators.

Also, in using quantitative elements, banks are expected to consider the change in lifetime Probability of Default (PD) by comparing the lifetime PD at the reporting date with the lifetime PD at initial recognition.

The criteria for relative quantitative increases in PD indicative of a significant increase in credit risk should be defined and documented by banks.

It stated that the assessment by banks should among others consider changes in credit risk at counterparty and individual credit level.

“Generally, most qualitative factors indicative of a significant increase in credit risk are reflected in PD models and therefore, are included in the quantitative assessment.

“However, where it is not possible to include all current information about qualitative factors in the quantitative assessment, banks should recalibrate PDs or adjust estimates when assessing significant increases in credit risk or calculating Expected Credit Losses (ECLs).

“The CBN expects that financial assets which are more than 30 days past due or have been granted forbearance should be considered to have significantly increased in credit risk.

“However, the CBN expects banks not to rely solely on the 30 days past due presumption, but to incorporate reasonable and supportable forward-looking information.

“The 30 days past due presumption can only be applied if the forward looking information is not available without undue cost or effort.

“Where the 30 days past due presumption is rebutted on the basis that there has not been a significant increase in credit risk, the bank shall accompany the assertion by documented, reasonable and supportable information that a more lagging criterion is appropriate.

“The CBN, however, expects that this would only be used in limited circumstances.

“Where a bank sets its transfer threshold for groups of financial assets, it is important that all financial instruments in that portfolio must have similar credit risk characteristics at initial recognition such as a credit rating within a relatively narrow band.

“In assessing whether there is an increase in credit risk or not, banks are required to consider macroeconomic indices and sector/industry/geographical idiosyncrasies and ensure that economic assumptions are consistent across all risk management and capital planning documents,” it added.

Furthermore, under the IFRS 9 reporting, the central bank said banks should consider both counterparty and individual exposures of the obligor and connected obligors, in determining significant increase in credit risk.

This would ensure that the impact of multiple exposures to the same obligor originated at different periods with different initial PDs have been taken cognisance of in compliance with IFRS 9.

Where there is evidence that there is a significant reduction in credit risk, banks would continue to monitor such financial instruments for a probationary period of 90 days to confirm if the risk of default has decreased sufficiently before upgrading such exposure from Lifetime ECL (Stage 2) to 12-months ECL (Stage 1), the banking sector regulator stated.

Banks are also required to put in place appropriate policies to ensure sound credit risk assessment and measurement processes. as well as systems, tools and data that appropriately aid the assessment of credit risk and computation of ECLs.

“Banks are required to compute ECLs on significant exposures and credit-impaired loans individually while ECLs for retail exposures and exposures to small and medium-sized enterprises that have less borrower-specific information may be measured on a collective basis.

“To measure ECLs on a collective basis, banks should have credit risk rating processes in place to appropriately group exposures on the basis of shared credit risk characteristics,” it said.

In another development, the naira slumped further against the US dollar on the parallel market yesterday, closing at N495, from N492 to the dollar at which it closed the previous day.

The drop was again attributed to the scarcity of the greenback. On the Bureau de Change (BDC) segment, however, the naira went for N400, while on the interbank FX market, the naira sold for N305 to the dollar.

The CBN on Monday had asked banks to submit bids for a special FX auction to clear the backlog of matured outstanding dollar obligations for select sectors comprising fuel importers, airlines, raw materials and machinery for manufacturing firms, and agricultural chemicals.

The central bank is expected to close all FX transactions today before the Yuletide celebrations.