lifetime ECLs, although the scenarios modelled for IFRS 9 will not necessarily be
stressed. However, estimating losses (especially given the need to consider multiple
scenarios) will still be challenging for many entities.
5.9.4
Events and new information obtained after ECLs have been calculated
In April 2015, the ITG (see 1.5 above) debated whether, and how, to incorporate events
and new information about forecasts of future economic conditions that occur after the
ECLs have been estimated. Due to operational practicality, entities may perform their
ECL calculations before the reporting period end in order to publish their financial
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statements in a timely manner (e.g. forecasts of future economic conditions developed
in November may be used as the basis for determining the ECLs at the reporting date as
at 31 December). Further information may then become available after the period end.
The ITG noted that:
• If new information becomes available before the reporting date, subject to
materiality considerations in accordance with IAS 8, an entity is required to take
into consideration this information in the assessment of significant increases in
credit risk and the measurement of ECLs at the reporting date.
• IFRS 9 does not specifically require new information that becomes available after
the reporting date to be reflected in the measurement of ECLs at the reporting
date. If new information becomes available between the reporting date and the
date the financial statements are authorised for issue, an entity needs to apply
judgement, based on the specific facts and circumstances, to determine whether it
is an adjusting or non-adjusting event in accordance with IAS 10 – Events after the
Reporting Period (see Chapter 34). Similarly, materiality considerations apply in
accordance with IAS 8.
• ECLs are similar in nature to the measurement of fair value at the reporting date,
in that movements in fair value after the reporting date are generally not reflected
in the measurement of fair value at the reporting date. [IAS 10.11]. For example, a
change in interest rates or the outcome of a public vote after the reporting date
would not normally be regarded as adjusting events for the ECL calculation.
• However, ECLs are a probability-weighted estimate of credit losses at the
reporting date (see 5.6 above). Accordingly, the determination of ECLs should take
into consideration relevant possible future scenarios based on a range of
expectations at the reporting date, using the information available at that date.
Hence, the probabilities attached to future expected movements in interest rates
and expected outcomes of a future public vote based on information available at
the reporting date would be reflected in the determination of ECLs at that date.
• Entities need robust processes and appropriate governance procedures for
incorporating information, including forecasts of future economic conditions, to
ensure transparent and consistent application of the impairment requirements in
IFRS 9. This includes processes for updating ECLs for new information that becomes
available after the initial modelling has taken place up until the reporting date.
5.9.5
Other issues concerning forward looking information
At its meeting on 16 September 2015, the ITG examined two further questions about the
use of forward-looking information:18
• the level at which forward-looking information should be incorporated – whether
at the level of the entity or on a portfolio-by-portfolio basis; [IFRS 9.B5.5.16, B5.5.51]
and
• how to determine what is reasonable and supportable forward-looking
information and how to treat shock events with material, but uncertain, economic
consequences, such as an independence referendum. The same considerations
could apply to events such as natural disasters. [IFRS 9.B5.5.49-54].
Financial instruments: Impairment 3779
With respect to the first issue, the ITG members confirmed that forward-looking
information should be relevant for the particular financial instrument or group of financial
instruments to which the impairment requirements are being applied. Different factors
may be relevant to different financial instruments and, accordingly, the relevance of
particular items of information may vary between financial instruments, depending on the
specific drivers of credit risk. This is highlighted in Illustrative Example 5 to IFRS 9 (see
Example 47.16 below), in which expectations about future levels of unemployment in a
specific industry and specific region are only relevant to a sub-portfolio of mortgage loans
in which the borrowers work in that industry in that specific region. Conversely, it was
also noted that if different financial instruments or portfolios being assessed share some
similar risk characteristics, then relevant forward-looking information should be applied
in a comparable and consistent manner to reflect those similar characteristics.
With respect to the second issue, the ITG members noted:
• There will be a spectrum of forward-looking information available, some of which will
be reasonable and supportable and some of which will have little or no supportable
basis. Determining the information that is relevant and reasonable and supportable and
its impact on the assessment of significant increases in credit risk and measurement of
ECLs can require a high level of judgement. In addition, it can be particularly
challenging and difficult to determine the economic consequences (or ‘second-order
effects’) of uncertain future outcomes. For example, while it may be possible to assess
the likelihood of a particular event occurring, it may be more difficult to determine the
effect of the event on the risk of a default occurring and/or on the credit loses that
would be associated with that event using reasonable and supportable information.
• The objective of the IFRS 9 requirements for measuring ECLs is to reflect
probability-weighted outcomes. Accordingly, information should not be excluded
from the assessment of ECLs simply because:
(a) the event has a low or remote likelihood of occurring; or
(b) the effect of that event on the credit risk or the amount of ECLs is uncertain.
• An entity should make an effort in good faith to estimate the impact of uncertain
future events, including second-order effects, on the credit risk of financial
instruments and the measurement of ECLs. The estimate should be based on all
reasonable and supportable information that is relevant and available without
undue cost and effort. Furthermore:
(a) estimates of ECLs should reflect an entity’s own expectations of credit losses;
however, entities should be able to explain how they have arrived at their
estimate and how it is based on reasonable and supportable information;
(b) estimates of ECLs are, by their nature, approximations, which will be updated
as more reasonable and supportable information becomes available over
time; and
(c) information does not necessarily need to flow through a statistical model or
credit-rating process in order to determine whether it is reasonable and
supportable a
nd relevant for a particular financial instrument or group of
financial instruments.
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• If an entity could determine that an uncertain event has an impact on the risk of a
default occurring, then it should be possible to make an estimate of the impact on
ECLs, despite the potentially large range of outcomes. However, in some
exceptional cases, it was acknowledged that it may not be possible to estimate the
impact on ECLs, despite an entity’s best efforts.
• In this regard, the importance of disclosure of forward-looking information that is
relevant, but that cannot be incorporated into the determination of significant
increases in credit risk and/or the measurement of ECLs because of the lack of
reasonable and supportable information was emphasised. Such disclosures should
be consistent with the objective in IFRS 7, which is to enable users of the financial
statements to understand the credit risk to which the entity is exposed.
• The need for good governance and processes in this area, because of the
uncertainties and continually changing circumstances associated with forward-
looking information. Furthermore, an entity should be able to explain what
information it had considered and why that information had been included or
excluded from the determination of ECLs.
This ITG discussion predated that in December 2015 on the use of probability-weighted
multiple economic scenarios (see 5.6 above) and some of the points that were noted by
the ITG probably need to be updated in the context of the later discussion. For instance,
the ITG members noted that the impact of scenarios about some uncertain future events
for which there is reasonable and supportable information, may need to be incorporated
through the use of overlays to the ‘base model’ on a collective basis. In applying a
multiple scenario approach, an entity will not use just one base model. Moreover, if the
lender needs to estimate ECLs by considering multiple economic scenarios, it would
follow that many shock events may already be included in that process (since some
shock events might be assumed to occur every year), with the event and its various
possible consequences occurring in some scenarios and not in others. There may still
need to be cases when the effect of shock events is added through an additional ‘overlay’
to the modelled calculation of ECLs but, if so, as noted by the ITG members, care needs
to be taken to avoid double counting the consequences of the event with what has
already been assumed in the model.
Banks will also need to take account of guidance from their regulators (see 7.1 below).
The ITG members also noted that the effects of uncertain future events may need to be
reflected in the assessment of whether there has been a significant increase in credit risk.
6
GENERAL APPROACH: DETERMINING SIGNIFICANT
INCREASES IN CREDIT RISK
One of the major challenges in implementing the general approach in the IFRS 9 ECL
model is to track and determine whether there have been significant increases in the
credit risk of an entity’s credit exposures since initial recognition.
The assessment of significant deterioration is key in establishing the point of switching
between the requirement to measure an allowance based on 12-month ECLs and one
that is based on lifetime ECLs. The assessment of whether there has been a significant
Financial instruments: Impairment 3781
increase in credit risk is therefore often referred to as ‘the staging assessment’. The
standard is prescriptive that an entity cannot align the timing of significant increases in
credit risk and the recognition of lifetime ECLs with the time when a financial asset is
regarded as credit-impaired or to an entity’s internal definition of default. [IFRS 9.B5.5.21].
Financial assets should normally be assessed as having increased significantly in credit
risk earlier than when they become credit-impaired (see 3.1 above) or default occurs.
[IFRS 9.B5.5.7].
As this area involves significant management judgement, entities are required to provide
both qualitative and quantitative disclosures under IFRS 7 to explain the inputs,
assumptions and estimation used to determine significant increases in credit risk of
financial instruments and any changes in those assumptions and estimates (see 15 below
and Chapter 50 at 5.3). [IFRS 7.35F(a), 35G(a)(ii), 35G(c)].
At its meeting in December 2015, the ITG members reaffirmed that unless a more
specific exception applies, IFRS 9 requires an entity to assess whether there has been a
significant increase in credit risk for all financial instruments, including those with a
maturity of 12 months or less. Consistently with this requirement, IFRS 7 requires
corresponding disclosures that distinguish between financial instruments for which the
loss allowance is equal to 12-month or lifetime ECLs. In addition, the ITG members
noted that:
• the assessment of significant increases in credit risk is distinct from the
measurement of ECLs as highlighted by paragraph 5.5.9 of IFRS 9. For example, a
collateralised financial asset may have suffered a significant increase in credit risk,
but owing to the value of the collateral there may not be an increase in the amount
of ECLs even if measured on a lifetime rather than a 12-month basis;
• assessing changes in credit risk would be consistent with normal credit risk
management practices; and
• the expected life of a financial instrument may change if it has suffered a significant
increase in credit risk.
Finally, the ITG noted the importance of the IFRS 7 disclosure requirements and
observed that disclosing information regarding the increase in credit risk since initial
recognition provides users of financial statements with useful information regarding the
changes in the risk of default occurring in respect of that financial instrument (see 15
below and Chapter 50 at 5.3).
6.1
Change in the risk of a default occurring
In order to make the assessment of whether there has been significant credit
deterioration, an entity should consider reasonable and supportable information that is
available without undue cost or effort and compare: [IFRS 9.5.5.9]
• the risk of a default occurring on the financial instrument over its life as at the
reporting date; and
• the risk of a default occurring on the financial instrument over its life as at the date
of initial recognition.
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For loan commitments, an entity should consider changes in the risk of a default
occurring on the potential loan to which a loan commitment relates.
For financial guarantee contracts, an entity should consider the changes in the risk that
the specified debtor will default. [IFRS 9.B5.5.8].
An entity is required to assess significant increases in credit risk based on the change in
the risk of a default occurring over the expected life of the financial instrument rather
than the change in the amount of ECLs. [IFRS 9.5.5.9]. It should be noted that in a departure
from the Basel regulatory wording and to avoid suggesting that statistical models are
required (including the PD approach), the IASB c
hanged the terminology from
‘probability of a default occurring’ to ‘risk of a default occurring’. [IFRS 9.BC5.157].
In order to make the IFRS 9 impairment model operational, the IASB considered a
number of alternative methods for determining significant increases in credit risk, but
these were rejected for the following reasons:
• Absolute level of credit risk: The IASB considered whether an entity should be
required to recognise lifetime ECLs on all financial instruments at, or above, a
particular credit risk at the reporting date. Although this approach is operationally
simpler to apply (because an entity is not required to track changes in credit risk),
such an approach would provide very different information. It would not
approximate the economic effect of changes in credit loss expectations subsequent
to initial recognition. In addition, it may also result in overstatement or
understatement of ECLs, depending on the threshold set for recognising lifetime
ECLs. [IFRS 9.BC5.160]. However, the IASB noted that an absolute approach could be
used for portfolios of financial instruments with similar credit risk at initial
recognition, by determining the maximum initial credit risk accepted and then
comparing the maximum initial credit risk to the credit risk at the reporting date
(see 6.4.5 below). [IFRS 9.BC5.161].
• Change in the credit risk management objective: The IASB also considered
whether the assessment of significant deterioration should be based on whether an
entity’s credit risk management objective changes (e.g. monitoring of financial
assets on an individual basis, or a change from collecting past due amounts to the
recovery of these amounts). This approach is operationally relatively easy to apply.
However, it is likely to have a similar effect to the IAS 39 incurred loss model and,
hence, may result in a delayed recognition of ECLs. [IFRS 9.BC5.162].
• Credit underwriting policies: The IASB further considered whether the change in
the entity’s credit underwriting limit for a particular class of financial instrument at
the reporting date (i.e. an entity would not originate new loans on the same terms)
should form the basis of assessing significant increase in credit risk. The IASB
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