Step 3 Define significant increase in credit risk

The assessment of a significant increase in credit risk is paramount in determining when to switch between 12-month Expected Credit Losses (ECL) and the lifetime ECK basis.

This assessment is conducted each reporting date and entails consideration of changes in the risk of default occurring over the expected life of the financial instrument, rather than changes in the amount of ECL (ie the magnitude of loss) if the default were to occur.

Determining significant increases in credit risk

The transition from recognising 12-month expected credit losses (i.e. Stage 1) to lifetime expected credit losses (i.e. Stage 2) in IFRS 9 Financial Instruments is based on the notion of a significant increase in credit risk over the remaining life of the instrument. The focus is on the changes in the risk of a default, and not the changes in the amount of expected credit losses. For example, for highly collateralised financial assets such as real estate backed … Continue reading

Possible indicators for ‘Lifetime Expected Credit Loss’

IFRS 9 sets out guidance (IFRS 9.B5.5.17) to assist entities in determining when a provision for lifetime expected credit losses is required. Entities may consider the following factors when making this determination:

  • Significant changes in internal pricing indicators of credit risk for a particular financial instrument or similar financial instruments with the same term
  • Other changes in the rates or terms of an existing financial instrument that would be significantly different if the instrument was newly originated or issued at
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The general approach

This is part of the expected credit losses in IFRS 9 Impairment of Financial Instruments

Identifying whether a significant increase in credit risk has occurred

A critical factor in applying the general approach is whether the credit risk of a loan or receivable has increased significantly relative to the credit risk at the date of initial recognition. This is the trigger which causes the entity to change the basis of its calculation of the loss allowance from 12 month … Continue reading