Diversity in forward-looking macroeconomic scenarios

Mon 23 Oct 2023

Under IFRS 9, forward-looking information is a key component of Expected Credit Loss (ECL) calculations. However, forward-looking information requires a significant level of judgement, making comparisons difficult to navigate. Indeed, similar to the use of post-model adjustments, forward-looking scenarios have also been reported by stakeholders in the context of the IFRS 9 impairment post-implementation review as a point of attention. Specifically, stakeholders point to the diversity observed in the number of scenarios entities identify, the variables considered, and the weightings attached to particular scenarios. Based on an analysis of 26 banks in 11 European countries, the Mazars benchmark study on Financial Reporting of European Banks in May 2023 using the banks’ year-end 2022 financial statements also notes differing interpretations of forward-looking information, both in terms of the evolution of the macroeconomic scenarios used to calculate the ECL and in the forecasts of the underlying data used to prepare them.

Charting the underlying parameters of macro-economic scenarios

With regard to macro-economic scenarios used to calculate the forward-looking component of ECL, most of the banks in the panel changed their weightings in favour of pessimistic scenarios to the detriment of the optimistic scenarios. However, French banks stand out for having revised the weighting of their negative scenarios downwards.

According to the study, 18 banks weighted their downside scenarios at or above 20% in YE 2022. Whereas in the same period, seven banks weighted their upside scenarios at or above 20%, with heterogeneous weightings for each type of scenario – upside, baseline and downside – even within each country.

The underlying parameters of macroeconomic scenarios disclosed also show different expectations, especially between the Eurozone and the UK. Almost all the banks using the Eurozone GDP growth rate are more conservative than the ECB for the next three years, whereas the banks using the UK GDP growth rate all show more optimistic assumptions than the Bank of England (BOE)

A lack of comparability

One of the challenges of a principle-based approach is that interpretations will differ depending on the judgement of banks’ in-house economic research departments. By definition, therefore, forward-looking information can only ever be an assessment of economic factors taken into account by individual banks. This explains why weightings can often be markedly different, even for the same scenario and within the same country. 

While banks will disclose the most important parameters used, the lack of detail on all the underlying parameters makes full comparisons between banks’ macroeconomic parameters more challenging, notably how those parameters are integrated into scenarios.

Timing is a further issue with some banks in the study not presenting their GDP growth assumptions until 2025, further hindering full comparability between sample banks.

The challenge of closer alignment

The International Accounting Standards Board (IASB) is currently placing its attention on the diversity of practices observed in the use of forward-looking information and underlying parameters of economic scenarios. While every bank will have specific areas of economic sensitivities based on individual assessment, the question arises as to how to reconcile these specificities while ensuring the best possible understanding and comparability of the information communicated to stakeholders.

Although IFRS 9 has introduced a number of new disclosures to enable a better understanding of banks’ credit risk, recent developments in the measurement of credit risk may ultimately call for renewed efforts in terms of financial reporting by these institutions.