This blog talks about various components that banks need to build for IFRS 9 Impairment Modeling.

1. Building Blocks of
Impairment Modeling
As highlighted in our previous post, one of the key areas of focus pertaining to IFRS 9 principles is
credit risk modeling, which is required for appropriate estimations of Expected Credit Loss (ECL). In
this post we will discuss the key components of Impairment Modeling, which will call for significant
attention of the Banks' management to ensure a successful implementation.
IFRS 9 uses a “three stage model” for expected credit losses based on changes in credit quality since
initial recognition. Let us deliberate on the expectations pertaining to the impairment
ISSUE 02
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IAS 39 – Incurred Loss Model
Credit losses are recognized only
on the occurrence of a loss event
IFRS 9 – forward-looking
expected credit loss model
Recognizes 12-month loss
allowance at initial recognition, and
lifetime loss allowance on significant
increase in credit risk
Impairment
Recognition of Interest
Specific Provisions
Non-Performing
General Provision/
Collective Provisions
Performing Watch-List
Significant increase in credit risk
(PD) since initial recognition
Object evidence
of impairment
Page 1
Gross Carrying Amount
12-month ECL
Net Carrying
Lifetime Expected Credit Loss
Stage 1 Stage 2 Stage 3

2. Page 2
The standard does not prescribe specific approaches used to estimate ECLs, but stresses that
the approach adopted must reflect the following–
a. Probability weighted outcome: Rather than incorporating a best case or worst case scenario, the
ECLshould in entirety reflect the possibility that a credit loss occurs and the possibility that no credit
loss occurs;
b. The time value of money: Estimates of ECLshould be discounted to the reporting date;
c. Information Set: Reasonable and supportable forward looking information should be considered,
including that with regard to macroeconomic scenario
ECL is an estimate of present value of cash shortfalls over the life of the financial instrument,
and therefore, when measuring 12-month and lifetime ECL, banks would need to consider the
following requirements:
a. Assessment of significant increase in credit risk (stage assessment) – For financial assets
which are in stage 1, 12-month ECL estimates are required, and for the assets in stage 2 and 3,
lifetime ECLestimates are essential.
b. Definition of Default – IFRS 9 requires banks to formalise the definition of default, which is
expected to be consistent with other credit risk management practices of the bank.
c. Risk Quantification (PD/LGD approach)
• Estimation of 12-month and lifetime Probability of Default (PD)
• PD calibration (TTC PD to PITPD)
• Calculation of PD term structure
• Effective Maturity (expected versus contractual maturity)
• Estimation of Loss given default (LGD) and Exposure at Default (EAD)
d. Estimation using Loss Rate approach – Using this approach, banks would need to develop loss-
rate statistics on the basis of the amount written off over the life of financial assets. Banks are also
expected to adjust these historical credit loss trends for current conditions and expectations about
the future.
In the coming week, we will be discussing the BCBS' expectations for high quality implementation of
IFRS 9 standards.
This space aims to answer your queries pertaining to IFRS 9 principles. In case, you have any queries
pertaining to IFRS 9 which you wish to discuss, do leave your comments.
Contact: | www.linkedin.com/company/aptivaaIFRS9.Insights@aptivaa.com Website: www.aptivaa.com |