Rebuttable presumption significant increase in credit risk

Rebuttable presumption significant increase in credit risk – IFRS 9 contains a rebuttable presumption that credit risk has increased significantly when contractual payments are more than 30 days past due. This means that when payments are 30 days past due, the financial asset is considered to have moved from Stage 1 to Stage 2, and lifetime expected credit losses are recognised. Past due is defined as failure to make a payment when that payment was contractually due. Rebuttable presumption significant increase in credit risk

The other simplification is for low credit risk financial assets.

Note: Contractual payment dates can be different for different clients, difference product, different regions and so on! Rebuttable presumption significant increase in credit risk

Lifetime ECL are expected to be recognized before a financial asset becomes delinquent. If forward-looking information is reasonably available, an entity cannot rely solely on delinquency information when determining whether credit risk has increased significantly since initial recognition; it also needs to consider the forward-looking information. However, if information that is more forward-looking than past due status is not available, there is a rebuttable presumption that credit risk has increased significantly since initial recognition no later than when contractual payments are more than 30 days past due. Rebuttable presumption significant increase in credit risk

This presumption can be rebutted if there is reasonable and supportable evidence that, regardless of the past-due status, there has been no significant increase in the credit risk: For example, where non-payment is an administrative oversight, instead of resulting from financial difficulty of the borrower. Another example is where management has access to historical evidence that demonstrates that there is no correlation between significant increases in the risk of a default occurring and financial assets on which payments are more than 30 days past due, but that evidence does identify such a correlation when payments are more than 60 days past due. Rebuttable presumption significant increase in credit risk

Explanation

Trade receivables have contractual payment terms, either based on specific contracts, general terms and conditions (print them on the back of your invoice!)  or customary business behavior (by the purchasing entity and/or the selling entity). IFRS 9 includes an assumption, that can be overruled in a policy document by management, that the entity has to suppose that a significant increase in credit risk for this late payment trade debtors has become apparent. Rebuttable presumption significant increase in credit risk

Without proof of the opposite, payments that are 30 days past due, transfer a financial asset into stage 2 and as a result lifetime expected credit losses are recognised. But management can overrule (in IFRS rebut) this assumption by analysing the case, document it and conclude whether there is or is not a case of an actual increase in credit risk for this specific case.

Another way of working this is to develop a management policy for the rebuttable presumption for more than 30 days past due by either shortly summarising each customer’s normal payment behavior (including for example whether or not credit notes were issued, invoices were partially not paid etcetera) and set an individual (but rather narrow) normal payment behavior norm (for example 26 – 35 days, 36 – 45 days). Instead of each individual customer an entity can also use one description for the complete customer portfolio (or 2 – 3 sub-groups) and set one common (but more global) customer portfolio behavior norm (for example 29 – 40 days, 41 – 50 days, 51 – 60 days). Rebuttable presumption significant increase in credit risk

Food for thought

If management does not have forward-looking information available at an individual level, and therefore assesses significant increases in credit risk using past-due information only (‘bottom up’ approach), the standard requires management to also consider forward-looking information at a portfolio level in order to determine whether there has been a significant increase in credit risk (‘top down’ approach).

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More-than-30-days-past-due rebuttable presumption in banking

In the limited instances where past-due information is the best criterion available to a bank to determine when exposures should move to the lifetime expected credit losses category, banks should pay particular attention to their measurement of 12-month ECL allowance to ensure that ECL are appropriately captured in accordance with the measurement objective of IFRS 9.

Moreover, banks should recognise that significant reliance on backward-looking information will introduce bias into the implementation of an expected credit losses (ECL) model and that the Committee expects banks to pay particular attention to ensuring that the objectives of the IFRS 9 impairment requirements (ie to reflect ECL that meet the stated measurement objectives and to capture all significant increases in credit risk) are met. Rebuttable presumption significant increase in credit risk

Example

Bank ABC provides mortgages to finance residential real estate in three different regions. The bank sets its acceptance criteria based on credit scores, and loans with a credit score above the ‘acceptance level’ are approved, as these borrowers are considered to be able to meet contractual payment obligations. When new mortgage loans are originated, Bank ABC uses the credit score to determine the risk of a default occurring as at initial recognition. Rebuttable presumption significant increase in credit risk

Individual assessment
In Region One, Bank ABC assesses each of its mortgage loans on a monthly basis by means of an automated behavioral scoring process that is based on current and historical past due statuses, indebtedness, loan-to-value measures (‘LTV measures’), customer behavior on other financial instruments with Bank ABC, the loan size and the time since the origination of the loan. Bank ABC updates LTV measures on a regular basis through an automated process that re-estimates property values using recent sales. Rebuttable presumption significant increase in credit risk

Historical data indicates a strong correlation between the value of residential property and default rates for mortgages, which is factored into the behavioral score. Bank ABC is able to identify significant increases in credit risk since initial recognition on individual customers before a mortgage becomes past due if there has been deterioration in the behavioral score.

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When the increase in credit risk has been significant, a loss allowance at an amount equal to lifetime ECL is recognized; otherwise, a loss allowance at an amount equal to 12-month ECL continues to be recognized. The loss allowance is measured using LTV measures to estimate the severity of the loss. Rebuttable presumption significant increase in credit risk

If Bank ABC is unable to update behavioral scores, for example, to reflect the expected declines in property prices, it uses reasonable and supportable information that is available without undue cost or effort to undertake a portfolio assessment to determine the loans on which there has been a significant increase in credit risk since initial recognition and recognize lifetime expected credit losses for those loans. Rebuttable presumption significant increase in credit risk

Portfolio assessment
In Regions Two and Three, Bank ABC does not have an automated scoring capability. Instead, for credit risk management purposes, Bank ABC tracks the risk of a default occurring by means of past-due statuses. It recognizes a loss allowance at an amount equal to lifetime ECL for all loans that have a past-due status of more than 30 days past due.

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Although Bank ABC uses past-due status information as the only borrower-specific information, it also considers other reasonable and supportable forward-looking information that is available without undue cost or effort to assess whether lifetime ECL should be recognized on loans that are not more than 30 days past due. This is necessary in order to meet the objective in paragraph 5.5.4 of IFRS 9 of recognizing lifetime expected credit losses for all significant increases in credit risk. Rebuttable presumption significant increase in credit risk

Region Two includes a mining community that is largely dependent on the export of coal and related products. Bank ABC becomes aware of a significant decline in coal exports and anticipates the closure of several coal mines. Because of the expected increase in the unemployment rate, the risk of a default occurring on mortgage loans to borrowers in these areas who rely on the coal mines is determined to have increased significantly, even if those customers are not past due at the reporting date. Rebuttable presumption significant increase in credit risk

Bank ABC segments its mortgage portfolio, by the industry within which customers are employed, to identify customers that rely on coal mining as the dominant source of employment (that is, ‘bottom up’ approach). For such groups of mortgages, Bank ABC recognizes a loss allowance at an amount equal to lifetime ECL while it continues to recognize a loss allowance at an amount equal to 12-month ECL for all other mortgages in Region Two. Newly originated loans to borrowers who rely on the coal mines in this community would, however, have a loss allowance at an amount equal to 12-month ECL, as they would not have experienced a significant increase in credit risk since initial recognition.

Rebuttable presumption significant increase in credit risk

Rebuttable presumption significant increase in credit risk

Rebuttable presumption significant increase in credit risk Rebuttable presumption significant increase in credit risk Rebuttable presumption significant increase in credit risk Rebuttable presumption significant increase in credit risk Rebuttable presumption significant increase in credit risk Rebuttable presumption significant increase in credit risk

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