Credit-impaired financial assets are those for which one or more events that have a detrimental impact on the estimated future cash flows have already occurred. If these financial assets had been originated or purchased before becoming credit impaired, they would be in Stage 3 and lifetime expected losses would be recognised.
Indicators that an asset is credit-impaired would include observable data about the following events:
Significant financial difficulty of the issuer or the borrower
- Breach of contract,
- The lender has granted concessions as a result of the borrower’s financial difficulty which the lender would not otherwise consider,
- It is becoming probable that the borrower will enter bankruptcy or other financial reorganisation,
- The disappearance of an active market for that financial asset because of financial difficulties,
- The financial asset is purchased or originated at a deep discount that reflects the incurred credit losses.
It may not be possible to identify a single discrete event. It could be the combined effect of several events may have caused financial assets to become credit-impaired.
For purchased and originated credit-impaired financial assets, a ‘day 1 loss’ is not recognised. Instead:
- Lifetime expected credit losses would be included in the estimated cash flows for the purposes of calculating the effective interest rate – resulting in a credit-adjusted effective interest rate,
- Interest revenue would be calculated on the net carrying amount at the credit-adjusted effective interest rate i.e. including expected credit losses,
- Expected credit losses would be discounted using the credit-adjusted effective interest rate,
- Any subsequent changes (favourable or unfavourable) from the initial expected credit losses would be recognised immediately in profit or loss.
Purchased credit-impaired financial assets are recorded on initial recognition at the transaction price without presentation of an allowance for expected contractual cash shortfalls that are implicit in the purchase price, but disclosures are required of contractual cash shortfalls that are implicit in the purchase price.
It is only in unusual circumstances that originated financial assets would be regarded as being credit impaired. Simply because originated assets might be of high credit risk does not mean that they are credit impaired.