A quick overview of credit impairment under IFRS 9 for banks. Those with limited or no understanding of new requirements for loan loss accounting, will get a quick high level understanding of an accounting standard that is the most significant change in accounting for loan losses in more than a decade.

1. A Quick Overview
Credit
Impairment
under IFRS 9
for Banks

2. 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

3. By the end of this
presentation, you will be able
to:
• Describe what is the new expected
credit loss model under IFRS 9
• What are the 3 stages of accounting
for credit losses and interest income
• What are the practical expedients
allowed
What will you learn?

4. I. Credit loss
model
III.
Practical
expedients
II. 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

5. 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
I. Credit loss
model
III.
Practical
Expedients
II. Stages

6. 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.)

7. 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.
Expected Loss Model (Contd.)

8. 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

9. 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.
Expected Loss Model (Contd.)

10. 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

11. I. Credit loss
model
III.
Practical
Expedients
II. Stages
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.)

12. Stage 1 Stage 2 Stage 3
Stages (Contd.)
Recognize 12 months
expected credit losses
Recognize
lifetime
expected credit
losses
Recognize
lifetime
expected credit
losses
Recognize interest revenue as
effective interest on gross
carrying amount
Recognize interest
revenue as effective
interest on gross
carrying amount
Recognize interest
revenue as effective
interest on
amortized cost
carrying amount

13. Stage 1
Stages (Contd.)
Recognize 12 months
expected credit losses
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.

14. 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.

15. 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).

16. 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.)

17. 3 Stages
To recap, lets look at the 3 stages again
Stages (Contd.)

18. Stage 1 Stage 2 Stage 3
Stages
Recognize 12 months
expected credit losses
Recognize
lifetime
expected credit
losses
Recognize
lifetime
expected credit
losses
Recognize interest revenue as
effective interest on gross
carrying amount
Recognize interest
revenue as effective
interest on gross
carrying amount
Recognize interest
revenue as effective
interest on
amortized cost
carrying amount

19. I. Credit loss
model
III.
Practical
Expedients
II. Stages
Now lets look at what are the practical
expedients under IFRS 9
Practical Expedients (Contd.)

20. Credit loss
model
Practical
Expedients
Stages
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.
Practical Expedients (Contd.)

21. 3 practical expedients allowed under IFRS 9
Practical Expedients (Contd.)
Information Set Low Credit Risk > 30 Days Past Due
Information
Set
Low Credit
Risk
Past Due
Rebuttable
Presumption

22. 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
Practical Expedients (Contd.)

23. 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.
Practical Expedients (Contd.)

24. 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

25. Credit loss
model
Practical
expedients
Stages
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

26. Can you answer these
questions?
• Describe what is the new expected
credit loss model under IFRS 9
• What are the 3 stages of
accounting for credit losses and
interest income
• What are the practical expedients
allowed
What did you learn?

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

28. Faraz Zuberi 2016
Los Angeles, California
USA
For questions and
comments, please write
to:
Faraz Zuberi
farazzuberi@yahoo.com