Step 3 Define Significant Increase In Credit Risk – FAQ | IFRS

Step 3 Define significant increase in credit risk

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 3 which started with an introduction in Impairment of investments and loans.

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 ECL 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.

Because of the judgmental and subjective process of measuring expected credit losses, IFRS 9 does not define ‘significant increase in credit risk’ and the reporting entity has to define this criterion in the context of its specific types of instruments and business environment. Step 3 Define significant increase in credit risk

Various approaches may be applied in assessing whether there has been a significant increase in credit risk for investments or loans. Step 3 Define significant increase in credit risk

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.

Ultimately the approach may vary according to the level of sophistication of the entity, the financial instrument and the availability of data. In many cases, qualitative and non-statistical quantitative information may be sufficient for the impairment assessment. In other cases a statistical model or credit rating process may be used. Alternatively a mixture of quantitative and qualitative information may also be relevant, see Step 1 on the identified examples of financial, market and management criteria. Consider developing an indicator-based approach to timely assess significant increase in credit risk of customers as part of the entity’s internal credit risk management practices.

IFRS 9 includes a rebuttable presumption that the condition for recognising lifetime ECL is met when payments are more than 30 days past due unless the reporting entity has information that is more forward-looking than data about past due payments (available without undue cost or effort), then that information needs to be considered and the entity cannot solely rely on past-due data.

Next step 4: Define low credit risk

Or jump to:

Step 1 Define DefaultStep 2 Decide to use the general or simplified approach, Step 5 Allocate receivables to high and low credit riskStep 6 Apply the provision matrixStep 7 Measure expected credit losses

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