Expected Credit Loss

From Open Risk Manual

Definition

Expected Credit Loss (ECL) in the context of IFRS 9 [1] is the probability-weighted estimate of credit losses (i.e., the present value of all cash shortfalls) over the expected life of the financial instrument. A cash shortfall is the difference between the cash flows that are due to an entity in accordance with the contract (scheduled or contractual cashflows) and the cash flows that the entity expects to receive (actual expected cashflows). Because expected credit losses consider the amount and timing of payments, a credit loss arises even if the entity expects to be paid in full but later than when contractually due.

ECL can be measured either at an individual exposure level or a collective portfolio level (grouped exposures based on shared credit risk characteristics)

Scope

The ECL approach applies to all instruments held at amortised cost as well as to all instruments held at fair value through other comprehensive income

Calculation Requirements

According the the IFRS 9 standard, the measurement of expected credit losses of a financial instrument should reflect:

  • an unbiased and probability-weighted amount of potential loss that is determined by evaluating a range of possible outcomes;
  • the time value of money; and
  • reasonable and supportable information that is available without undue cost or effort at the reporting date about past events, current conditions and forecasts of future economic conditions.

Usage

Under the new impairment approach introduced by IFRS 9 it is no longer necessary for a credit event to have occurred before credit losses are recognised (as with the previous incurred loss accounting approach). Instead, an entity always accounts for expected credit losses, and also changes in those expected credit losses.

The amount of expected credit losses is updated at each reporting date to reflect changes in credit risk since initial recognition and, consequently, more timely information is provided about expected credit losses.

Issues and Challenges

  • Given IFRS 9 is a new standard, there is currently little in terms of established best practise

See Also

References

  1. IFRS Standard 9, Financial Instruments

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