The Prudential Regulation Authority's published its latest ‘Dear CFO’ letter on the 30th September outlining its findings from a review of auditors IFRS 9 reports across major UK banks and building societies. This article provides a concise overview of the findings by exploring the emerging concerns that have come into the PRA's focus this year and the areas where firms have been acknowledged for making significant improvements in their capabilities and processes.
Emerging Concerns
- Governance and Controls over ECL Data
The PRA have performed a first-time review of the Governance and Controls around ECL data with two key areas highlighted:
- Critical Data Elements - The PRA requested that all Critical Data Elements (CDEs) are captured, including those used outside of core model execution (e.g., PMAs), including clarity and granularity of accountability for CDEs
- Data Quality Controls and Lineage - The balance between preventative and detective data quality controls should be assessed and the completeness and usability of end-to-end data lineage enhanced.
- Private Market Exposures
A completely new area of supervisory interest, the PRA has asked for auditors’ views on firms’ processes for identifying and monitoring credit risks in private market exposures and to ensure changes in ECL are reflected in a timely manner.
This is characterised as "forward looking work to support wider cross-firm supervisory analysis, rather than a finding from the current review", driven by challenges in aggregating exposures and obtaining reliable data on complex, leveraged, and correlated risks in this domain.
- Securitisations
While banks generally have a good grasp of the initial setup of Securitisations, the PRA found that they often don't consistently monitor if the promised protections (like guarantees) will actually work over time. The PRA wants banks to improve how they check these protections post-transaction and report clearly on the true risks involved.
Previous focus areas that have received an acknowledgment for improvements
- Overall Capabilities, Controls, and Governance - Firms demonstrated continuous improvement in their overarching capabilities, controls, and governance for ECL and climate risks
- Model Redevelopment - Progress was made in strategic model redevelopment, including replacing legacy models, introducing more granular borrower segmentation, and improving economic sensitivity, leading to reduced reliance on PMAs for long-standing limitations
- Model Monitoring - Model monitoring is more granular, automated, and frequent, particularly for newer models, with better alignment to model segmentation and increased repeatability
- Model Risk - Governance frameworks were generally effective, showing broader monitoring and validation coverage and more risk-sensitive model tiering
- Climate Risk - Firms demonstrated significant progress in analysing climate-related credit risks, incorporating more granular portfolio analysis, enhanced scenario analysis, and stronger model and data governance
- Recovery Strategies - There was further progress in developing more granular LGD models, with improved alignment to operational strategies and better monitoring for newer models