Lifetime Expected Credit Losses

Low credit risk operational simplification

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Low credit risk operational simplification

IFRS 9 contains an important simplification that, if a financial instrument has low credit risk, then an entity is allowed to assume at the reporting date that no significant increases in credit risk have occurred. The low credit risk concept was intended, by the IASB, to provide relief for entities from tracking changes in the credit risk of high quality financial instruments. Therefore, this simplification is only optional and the low credit risk simplification can be elected on an instrument-by-instrument basis.

This is a change from the 2013 ED, in which a low risk exposure was deemed not to have suffered significant deterioration in credit risk. The amendment to make the simplification optional was made in response to requests from constituents, including regulators. It is expected that the Basel Committee SCRAVL consultation document will propose that sophisticated banks should only use this simplification rarely for their loan portfolios.

For low risk instruments, the entity would recognise an allowance based on 12-month ECLs. However, if a financial instrument is not considered to have low credit risk at the reporting date, it does not follow that the entity is required to recognise lifetime ECLs. In such instances, the entity has to assess whether there has been a significant increase in credit risk since initial recognition that requires the recognition of lifetime ECLs.

The standard states that a financial instrument is considered to have low credit risk if: [IFRS 9.B5.22]

  • The financial instrument has a low risk of default
  • The borrower has a strong capacity to meet its contractual cash flow obligations in the near term
  • Adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil its contractual cash flow obligations Low credit risk operational simplification

A financial instrument is not considered to have low credit risk simply because it has a low risk of loss (e.g., for a collateralised loan, if the value of the collateral is more than the amount lent (see collateral) or it has lower risk of default compared with the entity’s other financial instruments or relative to the credit risk of the jurisdiction within which the entity operates.

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Purchased and originated credit-impaired financial assets – IFRS 9 Best Read

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Purchased and originated credit-impaired financial assets

Purchased and originated 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.

Purchased and originated credit-impaired financial assetsIndicators 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.

Food for thought – Interaction between definitions of ‘credit-impaired’ and ‘default’
The definition of ‘credit-impaired’ under IFRS 9 may differ from the entity’s definition of ‘default’ (see explanation here). However, an entity’s definition of default should be consistent with its credit risk management, and should consider qualitative factors. For example, many financial institutions apply regulatory definitions of default for accounting and regulatory purposes – e.g. those issued by the Basel Committee on Banking Supervision under which a default is considered to have occurred when it is unlikely that the obligor will be able to repay its obligation. The assessment of whether such a definition is met may be based on similar criteria to those used for assessing whether an asset is credit-impaired. In these cases, the asset would be considered to be in default when it is credit-impaired. (IFRS 9.5.5.37)

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1 Strong Read Determination of separable assets

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Determination of separable assetsDetermination of separable assets

– Businesses are created to bring together diverse resources and generate synergies that will be realised in jointly produced cash flows. While businesses typically acquire assets separately, they realise benefits from them jointly. If no synergies were anticipated, there would be no point in bringing resources together in the first place. As a result, combinations of resources where synergies are believed to exist typically command a higher price when sold jointly than they would when sold separately. This creates a problem for example for the fair value and realisable value bases, which typically look at the amounts that could be realised from the disposal of separable assets.

Consider the case of an item of … Read more

IFRS 9 ECL Model best read – Impairment of investments and loans

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Impairment of investments and loans

is about impairment in a ‘normal’ business not complicated accounting but straightforward accounting calculations.

Normal operations

Although the focus for IFRS 9 Financial Instruments is on financial institutions such as banks and insurance companies, ‘normal’ operating entities are also affected by IFRS 9. Maybe their investment and loan portfolios are less complex but in operating a business and as part of the internal credit risk management practice policy making it is still important to implement the impairment model under IFRS 9 Financial Instruments.

The objective of these approaches to expected credit losses or timely recording of impairments/loss allowances is to provide approaches that result in a situation in which very different reporting entities all … Read more

Expected credit losses on financial assets

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Expected credit losses on financial assets relates to the impairment requirements that are applied to:

In addition, although contract assets recorded in accordance with IFRS 15 Revenue from Contracts with Customers are excluded from the scope of IFRS 9, they are within the scope of its impairment requirements.

Three-stage approach

The impairment model follows a three-stage approach based on changes in expected credit losses … Read more

30 days past due rebuttable presumption – simple and sufficient

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Past due status and more than 30 days past due rebuttable presumption

– making loss provision calculations simple –

The second simplification available in IFRS 9 sets out a rebuttable presumption that the credit risk on a financial asset has increased significantly since initial recognition when contractual payments are more than 30 days past due. [IFRS 9.5.5.11]

The first simplification available in IFRS 9 is the low credit presumption.

When payments are 30 days past due, a financial asset is considered to be in stage 2 and lifetime expected credit losses are recognised.

An entity can rebut this presumption when it has reasonable and supportable information available that demonstrates that even if payments are 30 days or more past due, it does not represent a significant increase in the credit risk of a financial instrument.

This 30 days past due simplification permits the use of delinquency or past due status, together with other more forward-looking information, to 30 days past dueidentify a significant increase in credit risk. The IASB decided that this simplification should be required as a rebuttable presumption to ensure that its application does not result in an entity reverting to an incurred loss model.[IFRS 9.BC5.190]

The IASB is concerned that past due information is a lagging indicator. Typically, credit risk increases significantly before a financial instrument becomes past due or other lagging borrower-specific factors (for example, a modification or restructuring) are observed.

Consequently, when reasonable and supportable information that is more forward-looking than past due information is available without undue cost or effort, it must be used to assess changes in credit risk and an entity cannot rely solely on past due information. However, if more forward-looking information (either on an individual or collective basis) is not available without undue cost or effort, an entity may use past due information to assess changes in credit risks.

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The best 1 in overview – IFRS 9 Impairment requirements

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IFRS 9 Impairment requirements

forward-looking information to recognise expected credit losses for all debt-type financial assets

 

Under IFRS 9 Impairment requirements, recognition of impairment no longer depends on a reporting entity first identifying a credit loss event.

IFRS 9 instead uses more forward-looking information to recognise expected credit losses for all debt-type financial assets that are not measured at fair value through profit or loss.

IFRS 9 requires an entity to recognise a loss allowance for expected credit losses on:

IFRS 9 requires an expected loss allowance to be estimated for each of these types of asset or exposure. However, the Standard specifies three different approaches depending on the type of asset or exposure:

IFRS 9 Impairment requirements

* optional application to trade receivables and contract assets with a significant financing component, and to lease receivables

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Setting 1 complete scene the Expected Credit Losses model

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the Expected Credit Losses model

Setting the scene the Expected Credit Losses model, start here to get a good understanding of ECL loss allowances or continue, you decide……

The Expected Credit Losses model (ECL) should be applied to:Setting the scene: the Expected Credit Losses model

… Read more

Individual or collective assessment for impairment – Which 1 is best varies per case

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Individual or collective assessment for impairment - An entity should normally identify significant increases in credit risk and recognise lifetime ECLs

1 Best guide Debt instruments at FVOCI

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Debt instruments at FVOCI – A debt instrument is classified as subsequently measured at fair value through other comprehensive income (FVOCI) under IFRS 9 if it meets both of the following criteria:

  • Hold to collect and sell business model test: The asset is held withiSeries provision of distinct goods or servicesn a business model whose objective is achieved by both holding the financial asset in order to collect contractual cash flows and selling the financial asset; and
  • SPPI contractual cash flow characteristics test: The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

This business model typically involves greater frequency and volume of sales than the … Read more