Implementation of regulatory changes in lending
Legal changes are a daily routine in finance
A need to comply with all legal regulations is one of the key challenges faced by the finance sector. Various types of regulations affect activity of organisations offering accounts, deposits, loans or investment products. New laws sometimes lay down requirements, sometimes just recommendations.
Adjusting to new regulations is often lengthy and costly, it requires changes to internal strategies, policies, and procedures. Those changes affect the entire organisation, from sales, through customer relations, through internal operations and risk, to IT departments.
New guidelines in the loans area
The “EBA Guidance on Loan Origination and Monitoring” (EBA/GL/2020/06) is a good example of those regulations. The final version of this document was published by the European Banking Authority (EBA) on 29 May 2019.
The guidelines require financial institutions operating mainly in the EU and offering loans to develop and implement standards for a sound credit risk assessment and minimising credit risk while ensuring adequate protection for customers. The main goal of these regulations is to reduce the number of “bad loans”.
New guidelines replace and extend the Mortgage Credit Directive and Consumer Credit Directive previously implemented by banks.
Scope of EBA guidelines
The guidelines developed by the EBA apply to banks and other lenders operating in the EU. They are designed to protect and ensure fair treatment of all customers, from consumers to large enterprises. They aim to improve internal governance for credit granting and monitoring, loan origination procedures, pricing, valuation of immovable and movable property and monitoring framework.
The EBA guidelines also include completely new areas, such as usage of modern technology in the lending process to assess client’s creditworthiness and to make a credit decision.
They also introduce regulations addressing “environmentally sustainable lending” – they describe requirements for green lending, including the assessment of ESG factors.
The EBA document also includes KPIs that are recommended (although not required) for assessing the credit risk.
EBA guidelines – scope of changes
The implementation of such guidelines for lenders means adjustment of internal policies and procedures. The following have to be included in the internal regulations to comply with the EBA guidelines:
- evaluation of ESG factors and related risks;
- customer assessment based on uniform criteria;
- implementation of anti-money laundering and countering the financing of terrorism (AML/CFT) mechanisms;
- risk based pricing;
- using the risk-adjusted indicators (e.g. EVA, RORAC, RAROC) to measure the profitability;
- requirements for valuation of immovable and movable property to be carried out by certified experts.
Apart of organisational and procedural changes, another important areas of adaptation are loan origination platform and other IT solutions.
The EBA guidelines often require modifications or implementation of additional tools, e.g. for collecting customer data, determining the creditworthiness, transparent decision-making, and monitoring of existing loans using the early warning systems. The customer data collected must be consistent and reliable, as this data is used by lenders to make key decisions.
EBA has also identified a set of requirements that organisations interested in technology-enabled innovation should use in their lending processes, for example the use of AI-based models when assessing the credit risk. Outputs of such models should be explainable and interpretable.
How to facilitate adaptations to new regulations?
The IT solutions must allow for adaptation to changing market and legal requirements. They should facilitate implementation of organisational changes that require introduction of new activities or shifting existing ones between departments.
Loan origination management tools are often complemented by tools allowing for adjustments of screen content or generating documents using templates, useful in case of regulatory changes.
Bank teams should be able to to implement modifications internally. Solutions should allow for easy integration with other systems or services, which, due to the risk diversification, may be provided by other providers.
EBA gave financial institutions 13 months to implement the guidelines, they will be in force from 30 June 2021.
Meeting these deadlines meant intensive work of IT departments and external suppliers that will often continue until the EBA deadline.
Application of regulations for previously started loans that require changes to T&C will begin one year later – from 30 June 2022, and the provisions concerning monitoring framework will have to be adjusted from July 2024.
By Radosław Bekanowski, product manager at Comarch
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