The general approach

This is part of the expected credit losses in IFRS 9 Impairment of Financial Instruments

Identifying whether a significant increase in credit risk has occurred The general approach Expected credit losses

A critical factor in applying the general approach is whether the credit risk of a loan or receivable has increased significantly relative to the credit risk at the date of initial recognition. This is the trigger which causes the entity to change the basis of its calculation of the loss allowance from 12 month ECLs to Lifetime ECLs. To determine whether such an increase has occurred, an entity must consider reasonable and supportable information that is available without undue cost or effort, including information about the past and forward-looking information. Certain key presumptions apply in performing this test:

  • An entity may assume that credit risk has not increased significantly if a loan or receivable is determined to have “low credit risk” at the reporting date; e.g., the risk of default is low, the borrower has a strong capacity to meet its contractual cash flow obligations in the near term and adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil its contractual cash flow obligations. An example of a loan that has a low credit risk is one that has an external “investment grade” rating. An entity may use internal credit ratings or other methodologies to identify whether an instrument has a low credit risk, subject to certain criteria.
  • If reasonable and supportable forward-looking information is available without undue cost or effort, an entity cannot rely solely on past due information.
  • There is a rebuttable presumption that the credit risk has increased significantly when contractual payments are more than 30 days past due.

In summary the general approach is a s follows (see also Impairment of investments and loans):

  1. Define default – as mentioned above, one of the factors to include is the rebuttable 30 days past due presumption, other logical examples are:
    1. credit worthiness of the counterparty and more importantly negative changes therein,
    2. initiation of bankruptcy proceedings, although you might consider this to be recognised too late, the good or service has already been transferred,
    3. breaches of covenants.  The general approach Expected credit losses
  2. Define ‘significant increase in risk’ – Various approaches may be applied in assessing whether there has been a significant increase in credit risk for investments or loans. fine 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.

  3. Define ‘low credit risk’ – An example of a loan that has a low credit risk is one that has an external “investment grade” rating. An entity may use internal credit ratings or other methodologies to identify whether an instrument has a low credit risk, subject to certain criteria. The general approach Expected credit losses
  4. Allocate receivables (per counterpart) to low credit risks and higher than low credit risks – Low credit risk receivables are not going to be individually assessed for impairment, only the higher than low credit risk receivables will be included individually in the measurement of Expected Credit Losses.
  5. Measure Expected credit losses – Resulting in an unbiased and probability-weighted amount, including the time value of money and using reasonable and supportable information that is available without undue costs or effort.

The general approach Expected credit losses

Leave a Reply

Your email address will not be published. Required fields are marked *