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Measurement Of Expected Credit Losses In Financial Instruments Under IFRS 9 Under IFRS 9 standard relating to credit impairment model, the loss allowances for expected credit losses (ECLs) in financial assets are measured at 12 month ECLs & Lifetime ECLs in three stages: Stage 1 : If there is no significant increase in credit risk (SICR) since initial recognition, the loss allowance is to be measured at 12 Months ECL. Stage 2 : If there is a SICR & no objective evidence of impairment exists, the loss allowance is to be made at lifetime ECL. Stage 3 : If the financial asset has become credit impaired at reporting date, provision for ECLs is to be made at lifetime ECLs. ◼️12 month ECL are those that result from default events that are possible within 12 months after the reporting date. ◼️Lifetime ECL are those that result from all possible default events over the expected life of a financial instrument. ⚫️ What Is Credit Loss ? “credit loss” is the difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive, discounted at the original effective interest rate (EIR) or credit-adjusted EIR. ⚫️ What Are Expected Credit Losses? ECLs are the weighted average of credit losses with the respective risks of a default occurring as the weights. ⚫️ What Is Effective Interest Rate? EIR is the interest rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset or financial liability to the gross carrying amount of a financial asset or the amortised cost of a financial liability. 🟦 Estimation of ECLs needs to reflect: ▪️probability weighted outcome [ie it must consider probability that default will occur and that a default will not occur]. ▪️time value of money (ie reasonable rate between risk free rate & EIR). ▪️reasonable & supportable information that is available to entity at without undue cost or effort. 🟦 Main Components For Measurement of ECL ECL = PD% x LGD%x EAD 1️⃣ Probability of default (PD) is the likelihood of a borrower defaulting on a loan or other credit obligation. PD models are used to estimate the probability of default for individual borrowers or for a portfolio of borrowers. Key considerations for PD : data quality, variable selection, model specification, & model validation. 2️⃣ Loss Given Default (LGD) is the amount of loss that a lender incurs when a borrower defaults on a loan or other credit obligation. Key considerations for LGD: data quality, variable selection, model specification, & model validation. 3️⃣ Exposure At Default (EAD) is the total amount of credit exposure that a lender has at the time of default. EAD models are used to estimate the total exposure for individual borrowers or for a portfolio of borrowers. Key considerations for EAD :data quality, variable selection, model specification, & model validation. Thanks for reading….

📊 Understanding Expected Credit Loss (ECL) under IFRS 9 :- As financial reporting becomes increasingly comprehensive, IFRS 9 introduced the concept of Expected Credit Loss (ECL) to better represent potential credit risks. Unlike the previous "incurred loss" model, ECL takes a forward-looking approach, requiring companies to anticipate and account for potential credit losses. 🔍 What is ECL? ECL represents the weighted probability of expected credit losses across different scenarios, making it a key factor in financial instruments' impairment reporting. It includes 12-month ECL and Lifetime ECL depending on credit risk status: Stage 1: Assets without significant credit deterioration since initial recognition—measured with 12-month ECL. Stage 2: Assets with significant credit deterioration but not impaired—measured with Lifetime ECL. Stage 3: Assets impaired with objective evidence—also measured with Lifetime ECL. --- 📈 Formula for ECL Calculation The ECL calculation formula combines three main factors: Probability of Default (PD): Likelihood of the borrower defaulting over a certain period. Loss Given Default (LGD): Percentage of loss in case of default. Exposure at Default (EAD): The total value exposed to credit loss at default. 🔄 Example Calculation Let's assume we have a loan with the following data for a 12-month period: PD: 5% (0.05) LGD: 40% (0.4) EAD: $100,000 Using the formula: ECL = 0.05 * 0.4 * $100,000 = $2,000 This means the 12-month Expected Credit Loss for this loan would be $2,000. In the case of a Stage 2 or Stage 3 loan, the calculation would consider Lifetime PD and LGD values. 🔗 Why Does This Matter? ECL under IFRS 9 allows institutions to have a more realistic view of credit risk and ensures stakeholders have transparency regarding potential credit losses. This forward-looking model enhances the financial statement's accuracy and reliability, which is essential in today's economic environment. #IFRS9 #CreditRisk #ExpectedCreditLoss #FinancialReporting #Finance

IFRS 9 : Determining Expected Credit Loss For Financial Assets In The Banks Under IFRS 9, it is no longer necessary for a loss event to have occurred but instead an entity is required to account for ECLs on initial recognition of the financial asset (the ECL could be nil) and then separately account for changes in the ECL at each reporting date. Credit losses are the difference between the present value (PV) of all contractual cashflows and the PV of expected future cash flows. Expected credit losses ( ECLs) are the weighted average of credit losses with the respective risks of a default occurring as the weights. Estimation of ECLs needs to reflect probability weighted outcome [ie it must consider (at least) probability that default will occur and that a default will not occur. Second, ECLs must reflect time value of money (ie reasonable rate between risk free rate & effective interest rate. The expected credit loss is used to estimate the risk of loss due to a borrower's failure to repay a loan or meet contractual obligations. 🟦 Formula For Calculation of ECL The ECL is calculated by multiplying the PD, LGD, and EAD, adjusted by the discount factor for the present value of the expected loss. ECL = PD% *LGD% *EAD *DF% 🟦 Components Of ECL ECL calculation involves 4 key components: ▪️ Exposure at Default (EAD) ▪️ Probability Of Default (PD) ▪️ Loss Given Default (LGD) ▪️ Discount Factor (DF) This approach helps in provisioning for potential losses, ensuring that lenders maintain adequate capital reserves to cover credit risks. 1️⃣ Exposure At Default EAD estimates the total amount at risk at the time of default, reflecting the outstanding loan balance or credit exposure. EAD = Current Balance + Undrawn Commitments EAD measures the total exposure at the point of default. It includes all credit lines available to the borrower, not just the current balance. 2️⃣ Probability Of Default PD = Historical Default Rate or Scorecard Output PD is the likelihood that the borrower will default over a specific time period (e.g., one year). This can be estimated based on historical data or through statistical models. 3️⃣ Loss Given Default LGD = (1 - Recovery Rate) * 100% LGD represents the percentage of the EAD that is expected to be lost if a default occurs. Recovery rates can be estimated from past recoveries or industry data. LGD is measured through a combination of historical data analysis, recovery rates, and market conditions, among other factors. 4️⃣ Discount Factor DF = 1 / (1 + Discount Rate)^t The discount factor is used to present value the future cash flows (losses) back to the reporting date. 't' represents the time in years until the cash flow occurs. Thanks for reading…

IFRS 9 : Determining Expected Credit Loss For Financial Assets In The Banks Under IFRS 9, it is no longer necessary for a loss event to have occurred but instead an entity is required to account for ECLs on initial recognition of the financial asset (the ECL could be nil) and then separately account for changes in the ECL at each reporting date. Credit losses are the difference between the present value (PV) of all contractual cashflows and the PV of expected future cash flows. Expected credit losses ( ECLs) are the weighted average of credit losses with the respective risks of a default occurring as the weights. Estimation of ECLs needs to reflect probability weighted outcome [ie it must consider (at least) probability that default will occur and that a default will not occur. Second, ECLs must reflect time value of money (ie reasonable rate between risk free rate & effective interest rate. The expected credit loss is used to estimate the risk of loss due to a borrower's failure to repay a loan or meet contractual obligations. 🟦 Formula For Calculation of ECL The ECL is calculated by multiplying the PD, LGD, and EAD, adjusted by the discount factor for the present value of the expected loss. ECL = PD% *LGD% *EAD *DF% 🟦 Components Of ECL ECL calculation involves 4 key components: ▪️ Exposure at Default (EAD) ▪️ Probability Of Default (PD) ▪️ Loss Given Default (LGD) ▪️ Discount Factor (DF) This approach helps in provisioning for potential losses, ensuring that lenders maintain adequate capital reserves to cover credit risks. 1️⃣ Exposure At Default EAD estimates the total amount at risk at the time of default, reflecting the outstanding loan balance or credit exposure. EAD = Current Balance + Undrawn Commitments EAD measures the total exposure at the point of default. It includes all credit lines available to the borrower, not just the current balance. 2️⃣ Probability Of Default PD = Historical Default Rate or Scorecard Output PD is the likelihood that the borrower will default over a specific time period (e.g., one year). This can be estimated based on historical data or through statistical models. 3️⃣ Loss Given Default LGD = (1 - Recovery Rate) * 100% LGD represents the percentage of the EAD that is expected to be lost if a default occurs. Recovery rates can be estimated from past recoveries or industry data. LGD is measured through a combination of historical data analysis, recovery rates, and market conditions, among other factors. 4️⃣ Discount Factor DF = 1 / (1 + Discount Rate)^t The discount factor is used to present value the future cash flows (losses) back to the reporting date. 't' represents the time in years until the cash flow occurs. Thanks for reading…

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IFRS 9 : Determining Expected Credit Loss For Financial Assets In The Banks Under IFRS 9, it is no longer necessary for a loss event to have occurred but instead an entity is required to account for ECLs on initial recognition of the financial asset (the ECL could be nil) and then separately account for changes in the ECL at each reporting date. Credit losses are the difference between the present value (PV) of all contractual cashflows and the PV of expected future cash flows. Expected credit losses ( ECLs) are the weighted average of credit losses with the respective risks of a default occurring as the weights. Estimation of ECLs needs to reflect probability weighted outcome [ie it must consider (at least) probability that default will occur and that a default will not occur. Second, ECLs must reflect time value of money (ie reasonable rate between risk free rate & effective interest rate. The expected credit loss is used to estimate the risk of loss due to a borrower's failure to repay a loan or meet contractual obligations. 🟦 Formula For Calculation of ECL The ECL is calculated by multiplying the PD, LGD, and EAD, adjusted by the discount factor for the present value of the expected loss. ECL = PD% *LGD% *EAD *DF% 🟦 Components Of ECL ECL calculation involves 4 key components: ▪️ Exposure at Default (EAD) ▪️ Probability Of Default (PD) ▪️ Loss Given Default (LGD) ▪️ Discount Factor (DF) This approach helps in provisioning for potential losses, ensuring that lenders maintain adequate capital reserves to cover credit risks. 1️⃣ Exposure At Default EAD estimates the total amount at risk at the time of default, reflecting the outstanding loan balance or credit exposure. EAD = Current Balance + Undrawn Commitments EAD measures the total exposure at the point of default. It includes all credit lines available to the borrower, not just the current balance. 2️⃣ Probability Of Default PD = Historical Default Rate or Scorecard Output PD is the likelihood that the borrower will default over a specific time period (e.g., one year). This can be estimated based on historical data or through statistical models. 3️⃣ Loss Given Default LGD = (1 - Recovery Rate) * 100% LGD represents the percentage of the EAD that is expected to be lost if a default occurs. Recovery rates can be estimated from past recoveries or industry data. LGD is measured through a combination of historical data analysis, recovery rates, and market conditions, among other factors. 4️⃣ Discount Factor DF = 1 / (1 + Discount Rate)^t The discount factor is used to present value the future cash flows (losses) back to the reporting date. 't' represents the time in years until the cash flow occurs. Thanks for reading…

Expected Credit Loss (ECL) is a concept introduced in the International Financial Reporting Standards (IFRS) 9, which pertains to the measurement of financial instruments, particularly focusing on the recognition of credit losses. Here’s a summary of its key aspects: 1. Objective: The ECL model aims to provide a more forward-looking approach to recognizing credit losses, ensuring that entities account for potential future losses rather than solely relying on historical data. This proactive approach enhances the timeliness and relevance of financial reporting regarding credit risk. 2. Scope: ECL applies to financial assets measured at amortized cost, such as loans and trade receivables, and to certain financial assets measured at fair value through other comprehensive income (FVOCI). 3. Three-Stage Approach: Stage 1: Financial assets that have not experienced a significant increase in credit risk since initial recognition. In this stage, entities recognize 12-month ECL, which represents the expected credit losses that result from default events that are possible within the next 12 months. Stage 2: Financial assets that have experienced a significant increase in credit risk since initial recognition but are not yet deemed to be credit-impaired. Entities recognize lifetime ECL, which accounts for all possible default events over the life of the asset. Stage 3: Financial assets that are credit-impaired. For these assets, entities continue to recognize lifetime ECL, and interest revenue is calculated on the net carrying amount (i.e., after deducting the ECL allowance). 4. Significant Increase in Credit Risk: The determination of a significant increase in credit risk involves various factors, including changes in credit ratings, payment history, and macroeconomic conditions. Entities must develop criteria to assess when to move assets between stages. 5. Calculation of ECL: The calculation of ECL is based on historical data, current conditions, and reasonable and supportable forecasts of future economic conditions. This involves estimating the probability of default, loss given default, and exposure at default. 6. Disclosure Requirements: IFRS 9 mandates detailed disclosures about the ECL model, including how ECLs are calculated, the assumptions made, the credit quality of financial assets, and how changes in credit risk are assessed. 7. Impact on Financial Statements: The introduction of the ECL model under IFRS 9 has significant implications for the financial statements of entities, affecting the timing and amount of credit loss provisions, thereby impacting profit or loss and equity. Overall, the ECL framework enhances the quality of financial reporting by requiring entities to account for credit losses in a more timely and transparent manner, ultimately leading to improved risk management and financial stability.

Simplifying Proposed Expected Credit Loss Model For Impaired Assets In The Banks : IFRS 9 The requirement for impairment using expected credit loss approach under IFRS 9 applies to financial assets that are measured under amortised cost or at fair value through other comprehensive income. The above impairment reqt also applies to a lease receivable, a contract asset or a loan commitment, & a financial guarantee contract. The measurement of ECL should reflect: (a) an unbiased & probability-weighted amount that is determined by evaluating a range of possible outcomes; (b) the time value of money; & (c) reasonable & supportable information that is available without undue cost or effort at the reporting date about past events, current conditions & forecasts of future economic condition. 🟦 Dual Credit Loss Assessment Model For Credit Risk IFRS 9 requires that on each reporting date, if the credit risk on a financial asset has not increased significantly since initial recognition, the entity should measure the loss allowance for that financial asset at an amount equal to 12-month expected credit losses (12 Month ECL). However, on the reporting date, if the credit risk on a financial asset has increased significantly since initial recognition, the entity should measure the loss allowance at an amount equal to the lifetime expected credit losses (Lifetime ECL). Regardless of the above, loss allowance has to be measured always at an amount equal to lifetime ECL for trade receivables or contract assets & lease receivables. 🟦 Demystifying 12 Month ECL & Lifetime ECL ▪️The 12-month ECLs are the credit losses that arise through the expected lifetime of the instrument on account of events that are likely to occur in the subsequent 12 months. ▪️Lifetime ECLs are the expected credit losses that result from all possible default events over the expected life of the financial instrument. 🟦 Stages For Classification Of Financial Assets A three-stage classification of financial assets is envisaged: ▪️Stage 1 includes financial assets that have not had a significant increase in credit risk (SICR) since initial recognition or that have low credit risk at the reporting date. For these assets, 12-month expected credit losses are recognised & interest revenue is calculated on the gross carrying amount of the asset (ie. without deduction for credit allowance). ▪️Stage 2 includes financial instruments that have had a SICR since initial recognition (unless they have low credit risk at the reporting date) but that do not have objective evidence of impairment. For these assets, lifetime ECLs are recognised, but interest revenue is still calculated on the gross carrying amount of the asset. ▪️Stage 3 includes financial assets that have objective evidence of impairment at the reporting date. For these assets, lifetime ECL is recognised & interest revenue is calculated on the net carrying amount (i.e. net of credit allowance). Thanks for reading….

Extended Contractual Period for Revolving Finance in IFRS 9 What is Contractual Period? The contractual period typically refers to the short, predefined time (e.g., 30-60 days) during which a lender can revoke or modify the credit facility. Revolving credit products like credit cards, overdrafts, and running finance offer flexibility to borrowers, but they come with unique challenges in assessing credit risk. Why go beyond the contractual period? Real-world usage shows that borrowers often continue to draw down credit, make minimum payments, or delay repayments, resulting in extended credit exposure. IFRS 9 mandates that financial institutions account for these behavioral patterns and adjust their models to estimate ECL over a longer period, capturing the realistic risk horizon. We have shared the link to download an easy-to-use Excel calculator to help you estimate the extended contractual period for any revolving credit products. As an example, the tool includes dummy data for credit cards to demonstrate data inputs and results. However, the calculator does not account for the behavioral patterns and macroeconomic adjustments. https://lnkd.in/ds6nBrtt For a more comprehensive approach, Probmatrix offers a powerful and intuitive tool designed to calculate the dynamic expected life of revolving products in alignment with IFRS 9 requirements. This advanced tool accounts for critical factors such as borrower behavioral patterns, macroeconomic scenarios, Probability of Default (PD), and borrower ratings or buckets. Additionally, the tool is accompanied by detailed documentation to ensure ease of use and understanding. Please feel free to reach out to us. *Note: Save tool as .xlsm (Macro enabled workbook) #revolvingproducts #Contractualperiod #IFRS9 #riskmanagement #Risk #expectedlife

Distinction Between Basel Capital Accord And Expected Credit Loss Model In The Banks Prior to the implementation of Basel capital accord and IFRS 9, accounting standards relied on an "incurred loss" model, recognising losses only when evidence of default was present. This backward-looking approach often led to delayed recognition of losses, impacting financial stability and transparency. 1️⃣ SCOPE Basel capital accord primarily focuses on credit risk exposures held by banks, setting minimum capital requirements based on risk-weighted assets. Credit risk is only one of the components influencing capital needs. Whereas IFRS 9: ECL model primarily regulates financial reporting, dictating how expected credit losses are measured and recognised in financial statements. This directly impacts reported profits and losses. 2️⃣ MEASUREMENT Basel capital accord offers two approaches "Standardised" and "Internal Ratings-Based" (IRB). The standardised approach relies on external credit ratings and predefined risk weights, while IRB approach allows banks to use their internal models for more precise risk assessment. Whereas IFRS9 ECL model provides more flexibility but also demands more sophistication. Banks can select from various measurement models, including Probability of Default (PD), Loss Given Default" (LGD), and Effective Interest Rate. 3️⃣ TTC - Probability Of Default Or Point in Time - PD Under Basel capital accord, average estimate of default within next 12 months is taken into consideration for calculating PD. The PD reflects long run historical average over whole economic cycle [viz through the cycle (TTC) ] whereas under IFRS 9 model, PD is measured based on 12 month or lifetime ECL depending on credit quality of the asset. PD reflects current and future economic cycles to the extent relevant to the remaining life of the loan on a point-in-time (PIT) basis. 4️⃣ Loss Given Default In ECL Measurement Under Basel capital acvord, LGD means average estimate of the discounted values of post default recoveries (net of direct & indirect collection costs), whereas LGD under IFRS 9 means estimate of the discounted values of post default recoveries. The measurement period of LGD is dependent on the relevant performance of the asset. 5️⃣ Data Requirements Basel capital accord is less data intensive and relies mainly on historical internal and external data for measuring credit risk, whereas IFRS 9: ECL model is more data intensive. It requires comprehensive historical, current and forward looking economic data in measurement of ECL. Thanks for reading..