Expected Credit Loss versus Market Information
Contents
Expected Credit Loss versus Market Information
Expected credit losses reflect an entity’s own expectations of credit losses. However, when considering all reasonable and supportable information that is available without undue cost or effort in estimating expected credit losses, an entity should also consider observable market information about the credit risk of the particular financial instrument or similar financial instruments.[1]
The IFRS 9 does not retain the practical expedient available in IAS 39 to measure impairment on the basis of an instrument’s fair value using an observable market price. However, it requires that, as part of considering all reasonable and supportable information in measuring expected credit losses, an entity also considers observable market information about credit risk. Expected credit losses thus reflect the entity’s own expectations of credit losses informed by observable market information, rather than reflecting the views of market participants[2]
Relevant Market Information
Depending on the financial instrument, the range of market information that can be considered includes:
- Market prices for traded credit sensitive cash instruments (Bonds)
- Credit spreads (e.g. as implied by Credit Default Swaps)
Issues and Challenges
- The IFRS 9 standard does not attempt to prevent measurable differences between an entity's own ECL expectations and those of the market
- Using market information in the measurement of expected credit losses is not straightforward
- Market instruments may be influenced by other risk factors (imperfect proxies)
- The financial instrument may be have specific features that modify its ECL
- Extracting a unique credit curve from market observables is in general not possible and requires further assumptions
