The Central Bank of Sri Lanka (CBSL) directions on classification, recognition and measurement of credit facilities and other financial assets will come into effect from 01st January 2022 onwards. It’s paramount for bankers to understand the regulatory expectations in this regard. New directions were introduced with the objective of harmonizing the regulatory framework with Sri Lanka Financial Reporting Standards-SLFRS 9 Financial Instruments.
The regulator has emphasized the importance of having a comprehensive credit risk management framework while stipulating its main components. Accordingly, Licensed Commercial Banks (LCBs) are expected to have a framework covering all aspects of credit lifecycle of its financial assets which includes, policy on classification, potential risk, under performing loans and write-offs, guidelines on computing Expected Credit Losses (ECL) & disclosures.
A high-profile deliberation on this crucial theme conducted by Manil Jayesinghe, Country Managing Partner, Ernst & Young, Sri Lanka and Maldives and Rajith Perera, Partner, Financial Accounting Advisory Services of Ernst & Young, Sri Lanka to be held on 22 November 2021 where they will discuss regulatory expectations combined with Financial Reporting Risk Management challenges faced by banks.
Apart from the emphasize on governance, compliance with new regulation will induce other technical and operational changes for banking community. Mainly, change in the definition of Non-performing loans (NPL) may trigger system modifications and classification for certain segments of the loan portfolio while the specific and general provision based on the subclassification will cease to exist and provision determination will be based on SLFRS 9 Financial Instruments combined with the directive providing additional guidance as appropriate. Deliberation on “Significant Increase in Credit Risk” (SICR) will require lending officers to exercise judgement and have well documented policies and processes to ensure consistency in terms of staging its credit facilities. Another aspect which needs early intervention is on recognition of interest income for stage 3 facilities which shall be recognized in line with SLFRS 9 Financial Instruments. Banks may review the mechanism for income recognition as the interest suspension is no longer relevant with the revocation of the respective circulars.
Further, there will be impairment charges defined based on SLFRS 9 and the directive based on 12months Expected Credit Loss (ECL) and Lifetime ECL. Minimum Stage 1 Provision of 0.5% will be maintained and in the event 0.5% is not maintained adequate appropriations to be made from Equity.
Another important requirement under the new direction is on managing model risk. Banks are requested to develop comprehensive policies in relation to model governance covering life cycle of model development and validation. Given the increased use of sophisticated models with the implementation of SLFRS 9, regulatory requirement is timely to ensure accuracy and completeness of financial information. Further, if any changes in the credit models are required, the rationale and justification for such change shall be evaluated by the Chief Risk Officer, Integrated Risk Management Committee and approved by the Board of Directors.
The directive states that scope of internal audit function should be enhanced to independently evaluate the effectiveness of the credit risk assessment & measurements. Further, the Internal Audit function will at least annually, validate and evaluate all credit risk assessment models, inputs and assumptions used along with data smoothening. An assurance on the adequacy and effectiveness of back testing should be provided from third line of defense perspective.
Economists, banking and financial service professionals and others decision makers interested are invited to join for further deliberations on this crucial theme webinar with Ernst and Young, , on 22nd November 2021 from 09.00 am to 12.00 pm. For registrations contact Thilini Perera on Thilini.perera1@lk.ey.com or Tel. +94 770623529.