On 27 September 2024, the PRA published a letter that it had sent to chief financial officers of selected PRA-regulated deposit-takers which provides thematic feedback from the PRA’s review of written auditor reports received in 2024 covering IFRS 9 expected credit loss accounting (ECL) and accounting for climate risk.

A key message in the letter is that model risk continues to remain elevated. The PRA considers it crucial that firms challenge the completeness of post model adjustments (PMAs) to ensure provisions reflect actual expectations of credit losses. This includes the impact of the higher interest rate environment on affordability and refinance risk for retail and corporate exposures.

The annexes to the letter set out a range of practice the PRA saw during its thematic review as well as areas of focus for the near term and medium term.

For ECL, near term areas of focus are those the PRA views as priorities to enable the timely capture of credit risk. In particular, the PRA remains focused on the completeness of PMAs to ensure provision cover accurately reflects actual expectations of credit losses, as well as the pace of progress to implement model redevelopment plans and strengthen model risk management. Medium term areas of focus are those where the PRA anticipates further industry progress will take more time. Enhancing model monitoring and validation remains a priority for the PRA. It notes that it will take time for control environments around new models to mature. Auditors continue to highlight monitoring limitations and control observations.

For climate risks, near term areas of focus include:

• Identifying the climate-related risk drivers that could influence ECL for loan portfolios that have the highest sensitivity to climate risks.
• Use of quantitative analysis on the impact of climate-related risk drivers on ECL and significant increase in credit risk at a portfolio level.
• Identifying how economic scenarios and weightings used for ECL calculations should be adapted to incorporate climate-related risk drivers.

Medium term areas of focus include:

• Identifying the requirement for data and models, and implementing the changes necessary, to factor climate-related risk drivers into loan level ECL estimates.
• Enhance review and monitoring by second line risk teams of how models and scenarios used to calculate ECL incorporate climate-related risk drivers.

For the next round of written auditor reporting, the PRA has asked for auditors’ views on the firm’s progress against the areas of focus on ECL set out in the letter. The PRA encourages firms to engage with their auditor by performing their own assessment against the areas of focus.