12-month Expected Credit Losses

From Open Risk Manual

Definition

12-month Expected Credit Losses in the context of IFRS 9[1] denote the portion of Lifetime Expected Credit Losses that represent the expected credit losses that result from default events on a financial instrument that are possible within the 12 months after the reporting date.

Formula

Conceptually the definition is captured in the following mathematical expression


\mbox{ECL}_t^{12m} = \sum_{i=t}^{12m}  D(t,i) \mathbb{E}_{\mathbb{P}} (\mbox{LGD}_{i} \mbox{EAD}_{i} 1_{ \{ d_{i} = 1 \} } | F_t )
  • Where t is the reporting date
  • i denotes possible times of default / loss (normally associated with instrument cashflows) within the 12-month period
  • di is the random (unknown) event of default at time i
  • LGD denotes Loss Given Default
  • EAD denotes Exposure at Default
  • D(t,i) denotes the discount rate at time t (based on the Effective Interest Rate, for the different cashflow maturities i
  • Ft denotes the subjective but Forward-Looking Information set used formulate the estimate at time t
  • P denotes the subjective assignment of default probabilities to the events di

This formula captures the essence of the definition, in practice evaluation of the 12-month portion LECL may utilize a variety of simplified / approximate forms. A common simplification is the use of the concept of 1-year Probability of Default

References

  1. IFRS Standard 9, Financial Instruments



Contributors to this article

» Wiki admin