It is the responsibility of the board of directors of finance companies to maintain ECL provisions at an adequate level and to oversee that the company has adopted appropriate credit risk practices for the assessment and measurement of ECL provisions, in accordance with the company's stated policies and procedures, the applicable accounting framework and relevant SAMA rules and guidance.
|
Establishing a strong governance and controls framework over ECL estimation and reporting, focusing on data integrity and model validation is a key focus area for those charged with governance. A robust framework for assessing credit risk and measuring the level of provisions should include, but not limited to the following:
|
| i. | Clearly define key terms related to the assessment and measurement of ECL (such as loss events or default, SICR,etc.);
|
| ii. | Identify and describe roles and responsibilities of functions and personnel involved;
|
| iii. | Include, for collectively evaluated exposures, a description of the basis for creating groups of portfolios of exposures with shared credit risk characteristics;
|
| iv. | Identify and document the ECL assessment and measurement methods (such as a loss rate method, probability of default (PD)/loss-given-default (LGD) method, or other) to be applied to each exposure or portfolio;
|
| v. | Document the inputs, data and assumptions used in the ECL estimation process (such as historical loss rates, PD/LGD estimates and economic forecasts), how the life of an exposure or portfolio is determined (including how expected prepayments have been considered), the historical time period over which loss experience is evaluated, and any qualitative adjustments. Examples of factors that may require qualitative adjustments are the existence of concentrations of credit risk and changes in the level of such concentrations, increased usage of exposure modifications, changes in expectations of macroeconomic trends and conditions, and/or the effects of changes in underwriting standards and lending policies;
|
| vi. | Include a process for evaluating the appropriateness of significant inputs and assumptions into the ECL measurement method chosen. It is expected that the basis for inputs and assumptions used in the estimation process will generally be consistent period to period. Where inputs and assumptions change, the rationale should be documented;
|
| vii. | Address how ECL rates are determined (e.g., historical loss rates or migration analysis as a starting point, adjusted for current conditions, forward-looking information and macroeconomic factors). A finance company should have a realistic view of its lending activities and consider forward-looking information that is reasonably available, macroeconomic factors, and the uncertainty and risks inherent in its lending activities when estimating ECL. To ensure alignment and consistency of macroeconomic factors used to create ECL models, SAMA may require, at its discretion, finance companies to consider the possible effects of certain indexes and economic factors in a specific manner, from time to time.
|
| viii. | Consider the appropriateness of historical data/experience in relation to current conditions, forwardlooking information and macroeconomic factors, and document how management's experienced judgment is used to assess and measure ECL;
|
| ix. | Determine the extent to which the value of collateral and other credit risk mitigants incorporated in the lending agreements affect ECL;
|
| x. | Include criteria for restructurings/modifications of lending exposures and their impact on ECL;
|
| xi. | Outline the company's policies and procedures on write-offs and recoveries;
|
| xii. | Document the methods used to validate models used for ECL measurement (e.g., back-tests) including model risk management;
|
| xiii. | Review, evaluate, update, and report on the adequacy of expected credit losses by Internal Auditors as a third line of defense on an annual basis. Where a finance company's Internal Auditor is unable to perform such reviews, the company may engage an independent third party to provide assurance to the Board of Directors and Senior Management on the quality and effectiveness of the internal controls, risk management and governance systems and processes set up under the IFRS 9 framework;
|
| xiv. | Providing relevant, timely, accurate and useful disclosures on expected credit losses in accordance with internal, regulatory, and accounting requirements; and
|
| xv. | Establish key performance indicators (KPIs) relating to ECL estimation and processes for regular reporting of those KPIs. For example, staging assessment KPIs might include how many credit exposures moved directly from Stage 1 to Stage 3 and how many credit exposures are moved to Stage 2 only because they are 30 days past due (and not flagged by other transfer criteria prior to delinquency) or operational performance KPI may include input data completeness, exposure reconciled, etc.
|
The framework must be reviewed at least annually, or more frequently when the need arises especially when new information becomes available during the quarterly expected credit loss assessment process.
|
