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Article:

Assessing for significant increases in credit risk under IFRS 9

10 April 2018

The forward-looking expected credit loss (ECL) model in IFRS 9 represents a major change from the incurred loss model in IAS 39 and is challenging for many entities. In this article, we take a closer look at the assessment of significant increases in credit risk (SICR) which is used to determine the amounts of ECL to be recognised under the new model and requires considerable management judgement.

 

  What is the SICR assessment and why is it important?

Under the General Approach (see the September 2017 edition of Business Edge), the SICR assessment must be carried out at each reporting date in order to determine whether the credit risk of a financial instrument has increased significantly since initial recognition. This assessment determines which stage the instrument is in and the amount of ECL to recognise as illustrated below:

Has there been a SICR?

Relevant stage

ECL Measurement Basis

No

Stage 1

12-month ECL

Yes

Stage 2

Lifetime ECL

This is particularly important for instruments with a maturity greater than 12 months because lifetime ECL will be higher than 12-month ECL resulting in a higher impairment charge in profit or loss. In addition, while the 12-month and lifetime ECL will be the same for instruments with a maturity of 12 months or less, entities are still required to assess for SICR and apply the related disclosure requirements.

 

Are all entities affected?

Yes. While the SICR assessment is particularly important for financial institutions with large lending portfolios, corporates are also affected because they too are likely to have financial instruments that fall within the scope of the General Approach. Some of the most common examples include:

  • Related company loans and debt instruments, such as bonds held, that are classified at amortised cost or fair value through other comprehensive income, and
  • Certain issued financial guarantee contracts that are not measured at fair value through profit or loss (see the February 2018 edition of Business Edge).

The SICR assessment is only relevant for the General Approach and does not form part of the Simplified Approach, which applies to trade receivables, contract assets and lease receivables (see the April 2017 edition of Business Edge).

 

Essential considerations when assessing for SICR

As there is no prescribed method of assessing for SICR and no ‘bright line’ for what constitutes a ‘significant’ increase, entities need to develop their own policies which must be disclosed in their financial statements. While this is a very judgmental area, there are a number of ‘key requirements’ that any method used must incorporate:

Key Requirements

Points to note

Compare credit risk at initial recognition to credit risk at reporting date

  • Focus on the relative increase rather than the absolute level of credit risk.

Assess changes in risk of default (not loss) over the remaining expected life, ie changes in the lifetime risk of default

 

  • Default is defined more widely than payment defaults – i.e. if no payments are due for a certain period, there is still a risk of default
  • Effect of collateral /guarantees are typically excluded
  • Risk of default generally reduces over time even if credit risk stays the same.

Incorporate all relevant reasonable and supportable information

  • Past, current and forward looking information
  • Available without undue cost or effort
  • Including borrower specific and general and macro-economic information.

 



 

 

 

 

 

 

 

 

 

 

 

In addition, IFRS 9 also contains a list of qualitative factors that may be relevant to the assessment, including:

  • General economic and/or market conditions
  • Operating performance of the borrower
  • Breaches of covenant
  • Changes to contractual terms e.g. granting concessions such as interest waivers
  • Cash flow or liquidity issues
  • Credit rating
  • Payment delays and past due information.

While many financial institutions are likely to use a combination of a quantitative assessment such as changes in probabilities of default (PDs) together with a qualitative assessment incorporating changes in factors such as those listed above, the use of PDs is not required by the standard.

 

What does it mean for corporates?

In order to assess for SICR, entities need to understand the key factors affecting the credit risk of their financial instruments over their expected lives and develop methods of monitoring these changes.

In some cases, the assessment could be qualitative in nature based on an analysis of factors such as those listed above although whether (and how relevant) a particular factor is will depend on the specifics of the financial instrument being assessed. In making this assessment, entities need to consider both borrower specific information and information about the general economic and business environment. While much of this information may be available internally, entities may need to seek external sources of information in order to meet the requirements of IFRS 9, eg incorporating forward-looking macro-economic information.

 

Are there any simplifications that can be applied?

Yes, but these are limited in nature and do not apply in every circumstance. Two of the most relevant to corporates are:

  • 30 days past due rebuttable presumption: a SICR is assumed at this point. However, this is a backstop indicator and is only used if more forward-looking information is not available.
  • Low credit risk: there is a choice to assume no SICR. This is relevant for instruments with an external (or equivalent internal) rating of ‘investment grade’ or above in line with globally understood definitions of ‘low credit risk’.  

For help and advice on IFRS 9 please get in touch with your usual BDO contact or Dan Taylor.

Read more on IFRS 9:

IFRS 9 Explained - Hedge Accounting Dcumentation

IFRS 9 Explained – Issued financial guarantees

IFRS 9 Explained – Hedge Accounting - policy choices available on transition

IFRS 9 Explained – Solely Payments of Principal and Interest

IFRS 9 Explained – Business Models

IFRS 9 Explained – the new expected credit loss model

IFRS 9 explained - modifications of financial liabilities

IFRS 9 explained – the classification of financial assets

IFRS 9 explained – Hedge effectiveness thresholds

IFRS 9 explained - Impairment and the simplified approach

IFRS 9 Explained – Available For Sale Financial Assets
 

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