Towards a More Stable Banking Financial Position COVID-19 Impacts and IFRS 9 Post-Model Practices “Management Overlays”

Dr Karim F F Mohamed

doi:10.22158/ijafs.v4n1p69

Abstract

In the repercussions of the latest worldwide financial crisis that have occurred due to the corona virus reasons (COVID-19); unprecedented stressful economic conditions prevailed, coupled with significant recessionary waves reasoned of the worldwide imposed strict lock downs that have adversely affected most of the economic sectors across the globe. Based on such adverse conditions, and as banks were used to calculate their Expected Credit Losses (ECLs) within the provisioning systems (IFRS 9); the forward looking projections embedded at the banks models fell short to predict the COVID-19 hit, as well as objectively reflect the widely spread governmental rescue plans, such as payment holidays and moratoria schemes. Consequently, and based on such unprecedented challenges, new risk management practices—Management Overlays—have risen to help in terms of overcoming such a systemic uncertainty situation that added more hurdles with regard to banks models and forecasting powers. The researcher is discussing how banks can start using the management overlays, or post-model adjustments, according to each and every bank’s portfolio composition, trends, and stress testing outcomes, where risks and uncertainties cannot be adequately reflected in existing models, until the global regulators (e.g., central banks, and external auditing bodies), as well as the main research and rating agencies can reach and agree on the new set of the updated macroeconomic indicators that can be utilized globally, and per region, reflecting the new era post COVID-19, and supporting in building the new robust IFRS 9 models across the world effectively. Therefore, management overlays can play such a vital role in terms of fortifying the stability of the banking system through: ascertaining the adequacy of the banking provisioning systems, and guaranteeing the sufficiency of holding appropriate capital levels for confronting such an adverse and unprecedented situation of the COVID-19 pandemic, as well as similar situations in the future.

Highlights

The latest worldwide financial crises that have started in Q1-2020 due to the corona virus reasons, known under the name of COVID-19, have gotten out the questions as to the financial related models that are utilized by the global institutions, their forecasting risks, complexities and limitations
Data and Methodology This section sets out the approach and methodology for the research study sample analysis. It displays how the significant COVID-19 impairment risks facing banks, such as: HSBC which represents one of the main global banking pillars, and Emirates NBD as one of the main regional banks in the Middle East, were recognized, and how Management Overlays were measured and implemented. In this exploratory research paper, the researcher shall discuss how management adjustments/overlays can be used to buffer against forward-looking uncertain performance indicators of assets portfolios. 6.1 Conceptual Framework This research study examines the relationship between the Banking System Stability and the Post Provisions Model Adjustments (Management Overlays) The framework model is demonstrated in the following figure: 7. Results and Findings The following section illustrates the study selected sample and in light of the previous highlighted research study limitations. 7.1 HSBC The COVID-19 emergencies have put its shadows on the worldwide economy and unfavorably influenced the bank’s clients and their performance
The impact of the pandemic, besides the uncertainty overall conditions reasoned of the corona virus may prompt significant credit misfortunes on explicit exposures, which may not be completely calculated in Expected Credit Losses (ECLs) predictions

Summary

Introduction

The latest worldwide financial crises that have started in Q1-2020 due to the corona virus reasons, known under the name of COVID-19, have gotten out the questions as to the financial related models that are utilized by the global institutions, their forecasting risks, complexities and limitations. The expected increases in defaults and losses have not yet fully materialized due to the visible government support measures and payment moratoria that econometric models normally do not capture In this exploratory research paper, the researcher shall discuss how management adjustments/overlays can be effectively used to buffer against forward-looking uncertain performance indicators of assets portfolios. This research paper shall spot the light on the COVID-19 challenges, together with its massive adverse impacts on the utilized IFRS 9 models reasoned of the unprecedented pandemic situation that was not accounted for at any model across the globe, and the increasing reliance need placed on management overlays (based on expert judgement) to derive expected credit losses during the uncertainty and challenging systemic period. Sample banks were used to show the utilization and disclosures of the management overlays, and how they allowed for the judgmental/overlay concept as a risk mitigation tool to overcome the adverse economic effects of the pandemic not fully captured by the models

Research Study Hypothesis H0

Results and Findings

Conclusions and Recommendations