Building Blocks of IFRS 9 Impairment Modeling
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The document discusses the key components of impairment modeling required for estimating expected credit losses under IFRS 9. It explains that IFRS 9 uses a three stage model where 12-month expected losses are recognized initially and lifetime losses are recognized if credit risk increases significantly. It outlines the expectations for impairment modeling, including assessing credit risk increases, defining default, quantifying probability of default and loss given default, and estimating losses using probability-weighted and loss rate approaches.
Building Blocks of IFRS 9 Impairment Modeling
- 1. Building Blocks of Impairment Modeling As highlighted in our previous post, one of the key areas of focus pertaining to IFRS 9 principles is credit risk modeling, which is required for appropriate estimations of Expected Credit Loss (ECL). In this post we will discuss the key components of Impairment Modeling, which will call for significant attention of the Banks' management to ensure a successful implementation. IFRS 9 uses a “three stage model” for expected credit losses based on changes in credit quality since initial recognition. Let us deliberate on the expectations pertaining to the impairment ISSUE 02 Contact: | www.linkedin.com/company/aptivaaIFRS9.Insights@aptivaa.com Website: www.aptivaa.com | IAS 39 – Incurred Loss Model Credit losses are recognized only on the occurrence of a loss event IFRS 9 – forward-looking expected credit loss model Recognizes 12-month loss allowance at initial recognition, and lifetime loss allowance on significant increase in credit risk Impairment Recognition of Interest Specific Provisions Non-Performing General Provision/ Collective Provisions Performing Watch-List Significant increase in credit risk (PD) since initial recognition Object evidence of impairment Page 1 Gross Carrying Amount 12-month ECL Net Carrying Lifetime Expected Credit Loss Stage 1 Stage 2 Stage 3
- 2. Page 2 The standard does not prescribe specific approaches used to estimate ECLs, but stresses that the approach adopted must reflect the following– a. Probability weighted outcome: Rather than incorporating a best case or worst case scenario, the ECLshould in entirety reflect the possibility that a credit loss occurs and the possibility that no credit loss occurs; b. The time value of money: Estimates of ECLshould be discounted to the reporting date; c. Information Set: Reasonable and supportable forward looking information should be considered, including that with regard to macroeconomic scenario ECL is an estimate of present value of cash shortfalls over the life of the financial instrument, and therefore, when measuring 12-month and lifetime ECL, banks would need to consider the following requirements: a. Assessment of significant increase in credit risk (stage assessment) – For financial assets which are in stage 1, 12-month ECL estimates are required, and for the assets in stage 2 and 3, lifetime ECLestimates are essential. b. Definition of Default – IFRS 9 requires banks to formalise the definition of default, which is expected to be consistent with other credit risk management practices of the bank. c. Risk Quantification (PD/LGD approach) • Estimation of 12-month and lifetime Probability of Default (PD) • PD calibration (TTC PD to PITPD) • Calculation of PD term structure • Effective Maturity (expected versus contractual maturity) • Estimation of Loss given default (LGD) and Exposure at Default (EAD) d. Estimation using Loss Rate approach – Using this approach, banks would need to develop loss- rate statistics on the basis of the amount written off over the life of financial assets. Banks are also expected to adjust these historical credit loss trends for current conditions and expectations about the future. In the coming week, we will be discussing the BCBS' expectations for high quality implementation of IFRS 9 standards. This space aims to answer your queries pertaining to IFRS 9 principles. In case, you have any queries pertaining to IFRS 9 which you wish to discuss, do leave your comments. Contact: | www.linkedin.com/company/aptivaaIFRS9.Insights@aptivaa.com Website: www.aptivaa.com |