The main objective of IFRS 9 is to identify significant increases in credit risk (SICR) on a timely basis. The standard assumes that the reserves derived using forward-looking Expected Credit Loss (ECL) parameters would adequately offset the loan losses.
BBA’s analytics experts tested these assumptions on a sample of almost half of Nigeria’s banks. As risk rises (ECL/Gross Loans), the return (Net Interest Income/Gross Loans) also rises. The banks in sample dataset above the 45-degree line were considered to be performing optimally, whilst those below the 45-degree line were taking relatively excessive risk and generating sub-optimal returns.
Theoretically, banks plotted along the horizontal axis, taking on greater risk, should have a relatively higher percentage of loan loss reserves. In order to test this corollary, we ranked the banks in sample dataset from 9 to 1, with 9 being the highest risk and 1 as the lowest risk.
Banks risk-ranked from 6 – 9 were expected to have higher forward-looking reserves, underlying the presence of high risk loans in the loan book. On the flip side, banks 1 – 4 should be below the industry average. This lack of optimization can be attributed to factors, such as, lack of granular analysis, use of subjective management judgement rather than objective data, analysis and scoring system, and at the loan book level it skews loans from higher risk buckets contributing to excessive Stage 1 & 2 ECL-based reserve.
For those banks which set aside excessive reserve, even if they are above the 45-degree line, there is money on the table and an opportunity to further improve performance. BBA’s Profitability KPI addresses these “unexplained’ gaps in performance.
BBA’s Profitability KPI application harmonizes stakeholders’ expectations by integrating performance targets with business and functional accountability. It removes silos and promotes performance across verticals to achieve the shared purpose and goals.
With the combined power and intelligence of BBA's IFRS 9 and Profitability KPI, relationship, treasury and credit teams are able to perform the risk/reward analysis of deals and portfolios to determine the lifetime income, RAROC and other economic profitability metrics. Use of the elasticity of demand fine-tunes pricing to consolidate and amplify strategic advantage, share of wallet and bottom line.
Profitability KPI dashboard provides a snapshot at 10,000 feet and drill down capability of discrete loan performance within the portfolio on a real time basis, allowing decision-makers to quickly execute on strategies that enhance loan book performance.
Now is the time to connect with us at BBA to achieve increased profitability from reduced ECL. We’ll provide a quick diagnostic of immediate and sustainable reduction estimates for Stage 1 & 2 impairment charges.