Credit Impairment under IFRS 9 for Banks

A Quick Overview

Credit Impairment under IFRS 9 for Banks

Classification and Measurement

Impairment

Hedge Accounting

IFRS 9, IASBs new accounting standard on financial instruments, will replace IAS 39, effective January 1, 2018.

It contains three areas of accounting for financial instruments as shown in the diagram.

This presentation addresses ‘Impairment’, from the point of view of banks.

Introduction

By the end of this presentation, you will be able to:1.Describe what is the new expected

credit loss model under IFRS 92.What are the 3 stages of accounting

for credit losses and interest income3.What are the practical expedients

allowed

What will you learn?

I. Credit loss model

III. Practical expedientsII. Stages

IFRS 9, replaces IAS 39 for recognizing credit losses in banks accounting books.

Under IFRS 9, the approach for measuring credit risk and accounting for it has changed fundamentally from incurred loss model to expected credit loss model and carries the following 3 key components

Key Components

Previous to IFRS 9, an allowance for credit losses used to be estimated based on historical data, such as, delinquencies in repayments, impairment in collateral or other adverse conditions of the borrower.

This is called the incurred loss model. Meaning, the loss or conditions had already occurred before the allowance was booked.

Incurred Loss Model


III. Practical ExpedientsII. Stages

Credit loss

model

A criticism from 2008 financial crisis, was that the banks recognized credit loss allowance too late, i.e., based on historical information.

IFRS 9 introduces expected credit loss model, a forward looking model, to recognize credit losses expected over the life of the loan.

As a result, credit risk of a bank is more timely reflected in its financial statements.

Expected Loss Model (Contd.)

Credit loss

model

In a forward looking model, the banks will now have to estimate the expected credit losses before credit events have taken place.

In next slide you will see the 2 factors used in estimating expected credit losses under IFRS 9.


Probability of Default

Expected Loss

Reasonable and

Supportable Information

The expected credit losses (ECL) are estimated from the product of 2 factors:

PD: This is the weighted average of probability of losses from various scenarios

EL: Present value of expected losses (or PV of shortfall in cash over lifetime of asset)

IFRS 9 requires above to be calculated using reasonable and supportable information from past, present and future (e.g. economic outlook)

Factors in Calculating ECL

Credit loss

model

Banks already usually follow some estimation model, for capital planning, pricing or regulatory requirements, e.g. capital adequacy, stress testing, scenario analysis etc.

IFRS 9 aligns the above with accounting so that more useful information is presented to the users of bank’s financial statements.


Credit loss

model

There are also financial statements disclosures requirements that have to do with explaining:

- How the expected credit losses were estimated, and

- How was credit risk (or changes thereto) were assessed

Expected Loss Model



Second component is the Stages.

IFRS 9 establishes 3 stages for accounting for expected credit losses:

Stage 1- Initial recognition

Stage 2- Significant increase in credit risk

Stage 3- Credit losses incurred

Stages (Contd.)

Stage 1 Stage 2

Stage 3

Stages (Contd.)

Recognize 12 months expected credit losses

Recognize lifetime

expected credit losses

Recognize lifetime


Recognize interest revenue as effective interest on gross

carrying amount

Recognize interest revenue as effective

interest on gross carrying amount


interest on amortized cost

carrying amount

Stage 1

Stages (Contd.)


Recognize interest revenue as effective interest on gross carrying amount

In Stage 1, at the initial recording of the loan, the credit losses expected as a probability in the next 12 months (at reporting date) are recognized in P&L.

Interest income during this time is recognized at effective interest rate applied to the gross carrying amount of the loan.

Stage 2

Stages (Contd.)

Recognize lifetime expected credit losses

Recognize interest revenue as effective interest on gross carrying amount

In Stage 2, the credit losses expected over the lifetime of the loan, are recognized in P&L, if there is a significant increase in credit risk.

There is no change in how interest income is recorded.

Stage 3

Stages (Contd.)

Recognize lifetime expected credit losses

Recognize interest revenue as effective interest on amortized cost carrying amount

If the credit quality of the loan deteriorates further to the point that credit losses are actually incurred or that there is an actual credit impairment the loan moves to stage 3.

In Stage 3, there is no change in accounting for credit losses.

Interest income, however, now is recognized based on gross carrying amount minus the loss allowance (amortized cost).

Time Horizon

You must have noted, that for recognizing expected credit losses, there are 2 time horizons.

The 12 month horizon for recognizing expected credit losses is for the probability of default within the next 12 months (Stage 1).

However, when there is significant increase in credit risk for a loan or a group of loans, the bank will have to recognize the expected credit losses for the lifetime of the loan(s) at the reporting date (Stages 2 & 3).

Stages (Contd.)

3 StagesTo recap, lets look at the 3 stages again

Stages (Contd.)

Stage 1 Stage 2

Stage 3

Stages


Recognize lifetime


Recognize lifetime


Recognize interest revenue as effective interest on gross

carrying amount


interest on gross carrying amount


interest on amortized cost

carrying amount



Now lets look at what are the practical expedients under IFRS 9

Practical Expedients (Contd.)

Credit loss model

Practical ExpedientsStages

Some relief has been provided in implementing IFRS 9, so to make it easier for a wide range of companies (banking and non-banking).

Three practical expedients are highlighted next.


3 practical expedients allowed under IFRS 9


Information Set Low Credit Risk > 30 Days Past Due

Information Set

Low Credit Risk

Past Due Rebuttable

Presumption

Information Set

IFRS 9 allows for using information that is easily available to the organization without incurring high costs.

This is particularly true for small organization which does not have resources for more sophisticated data analysis.

However, for large internationally active banks, Basel guidance (see link below) on expected credit losses, indicates that such banks should not have to use this practical expedient as they already utilize sophisticated data.

www.bis.org/bcbs/publ/d350.pdf


http://www.bis.org/bcbs/publ/d350.pdf

Low Credit Risk

If the credit risk was low at the time of loan origination as an example, there no need to assess credit risk at reporting date and it can be assumed that the risk was still low. E.g. US treasuries

Basel guidance expects the large international banks to not use this practical expedient and assess all loans for significant increase in credit risk.


Past Due Rebuttable

Presumption

If a loan is more than 30 days past due, there is a rebuttable presumption that the credit risk has increased significantly and the banks will have to recognize life time credit losses.

For large international banks, Basel guidance points out that 30 days past due is a lagging indicator, so it should not be the primary factor for estimating expected credit losses.

Practical Expedients

Credit loss model

Practical expedientsStages

To recap all what we learnt:

IFRS 9 replaces IAS 39, effective Jan 1, 2018.

It introduces a new forward looking credit loss model.

It prescribes 3 stages of accounting for credit losses depending on credit risk and losses incurred.

It provides some relief in implementation, however, Basel expects internationally sophisticated banks to not use these practical expedients.

In Summary

Can you answer these questions?1.Describe what is the new expected

credit loss model under IFRS 92.What are the 3 stages of

accounting for credit losses and interest income

3.What are the practical expedients allowed

What did you learn?

Answers1. New credit loss model is forward looking in that now expected credit losses are estimated and recognized before a default or loss2. In stage 1, losses expected in 12 months are recognized, stage 2 and 3, losses expected lifetime of loan are recognized3. Practical expedients allowed are information set, low credit risk and past due rebuttable presumption

What did you learn?

Faraz Zuberi 2016Los Angeles, CaliforniaUSA

For questions and comments, please write to:

Faraz Zuberi [email protected]

mailto:[email protected]

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Credit Impairment under IFRS 9 for Banks