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. This is step 1 which started with an introduction in Impairment of investments and loans.
You have to do it, there is no definition of ‘Default’ in IFRS. That provides entities the room to tailor the definition to their internal credit risk management practices and consider qualitative indicators of default in addition to days past due. Step 1 Define Default – Impairment of investments and loans
IFRS 9 includes a rebuttable presumption that default does not occur later than 90 days past due date of the asset unless the reporting entity has reasonable and supportable information to corroborate a more lagging default criterion. Step 1 Define Default – Impairment of investments and loans
Logical examples of qualitative indicators of default include:
- credit worthiness of the counterparty and more importantly negative changes therein,
- initiation of bankruptcy proceedings, although you might consider this to be recognised too late, the good or service has already been transferred,
- breaches of covenants. Step 1 Define Default – Impairment of investments and loans
Be aware defining ‘Default’ is not science, it is a judgmental and subjective assessment of the financial fitness of an investment and loan portfolio, a single investment or a single loan.
Use a multi-criteria model for default risk assessment of counterparties, that incorporates value judgments and dealing with qualitative aspects. And it is more about the change in indicators over time than in just the current status of an indicator, is is getting worse, are only a few indicators getting worse and what is the answer you are receiving on questions after new orders are boarded.
Default assessment decisions are usually based on four types of information:
- information of a commercial nature, related to the supplier-customer’s relationship history;
- information of a financial nature, quantitatively assessed through some indicators;
- information related to the customer’s management; and Step 1 Define Default – Impairment of investments and loans
- information which mitigates the default risk (collateral and other guarantees).
Or jump to:
Step 3 Define significant increase in credit risk, Step 4 Define low credit risk, Step 5 Allocate receivables to high and low credit risk, Step 6 Apply the provision matrix, Step 7 Measure expected credit losses