Difference between revisions of "Expected Credit Loss"
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'''Expected Credit Loss''' (ECL) is the probability-weighted estimate of [[Credit Loss | credit losses]] (i.e., the present value of all cash shortfalls) over the ''expected life'' of a [[Financial Instrument]]. The concept is particularly important in the context of [[IFRS 9]] <ref>IFRS Standard 9, Financial Instruments</ref>. | '''Expected Credit Loss''' (ECL) is the probability-weighted estimate of [[Credit Loss | credit losses]] (i.e., the present value of all cash shortfalls) over the ''expected life'' of a [[Financial Instrument]]. The concept is particularly important in the context of [[IFRS 9]] <ref>IFRS Standard 9, Financial Instruments</ref>. | ||
| − | A ''cash shortfall'' is the difference between the cash flows that are due to an entity in accordance with | + | A ''cash shortfall'' is the difference between the [[Cash Flow | cash flows]] that are due to an entity in accordance with a contract (''the scheduled or [[Contractual Cash Flows | contractual cashflows]]'') and the cash flows that the entity expects to receive (''the actual expected cashflows''). Given that expected credit losses consider both 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 | + | ECL can be measured either on an ''individual exposure'' level or a collective ''portfolio level'' (grouped exposures based on shared credit risk characteristics) |
== Scope == | == Scope == | ||
| − | In IFRS 9 context the ECL approach | + | In IFRS 9 context the ECL approach applies to all instruments held at [[Amortised Cost |amortised cost]] as well as to all instruments held at [[FVOCI | fair value through other comprehensive income]] |
== Calculation Requirements == | == Calculation Requirements == | ||
According the the IFRS 9 standard, the measurement of expected credit losses of a financial instrument should reflect: | 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 | + | * 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 | * 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. | * 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. | ||
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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. | 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. | ||
| + | |||
| + | == Example == | ||
| + | There are many alternative ways to estimate expected credit loss, depending on the [[Credit Portfolio]], available data and models. For a more general discussion and the standard formula see [[Expected Loss]]. The following example illustrates the concept of probability weighted loss in a modeling framework that adopts three distinct scenarios and assigns to each a probability. | ||
| + | |||
| + | {| class="wikitable sortable" | ||
| + | |- | ||
| + | ! | ||
| + | ! Scenario Probability | ||
| + | ! Loss Year 1 | ||
| + | ! Loss Year 2 | ||
| + | ! Loss Year 3 | ||
| + | ! Loss Year 3 | ||
| + | ! Cumulative Loss | ||
| + | |- | ||
| + | | Scenario 1 | ||
| + | | 0.3 | ||
| + | | 100 | ||
| + | | 50 | ||
| + | | 100 | ||
| + | | 20 | ||
| + | | 270 | ||
| + | |- | ||
| + | | Scenario 2 | ||
| + | | 0.5 | ||
| + | | 200 | ||
| + | | 100 | ||
| + | | 150 | ||
| + | | 50 | ||
| + | | 500 | ||
| + | |- | ||
| + | | Scenario 3 | ||
| + | | 0.2 | ||
| + | | 400 | ||
| + | | 200 | ||
| + | | 100 | ||
| + | | 200 | ||
| + | | 900 | ||
| + | |- | ||
| + | | Probability-Weighted Loss Amount | ||
| + | | | ||
| + | | 210 | ||
| + | | 105 | ||
| + | | 125 | ||
| + | | 71 | ||
| + | | 511 | ||
| + | |} | ||
== Issues and Challenges == | == Issues and Challenges == | ||
* Given IFRS 9 is a new standard, there is currently little in terms of established best practise | * Given IFRS 9 is a new standard, there is currently little in terms of established best practise | ||
| − | |||
| − | |||
== References == | == References == | ||
Latest revision as of 17:42, 18 February 2022
Contents
Definition
Expected Credit Loss (ECL) is the probability-weighted estimate of credit losses (i.e., the present value of all cash shortfalls) over the expected life of a Financial Instrument. The concept is particularly important in the context of IFRS 9 [1].
A cash shortfall is the difference between the cash flows that are due to an entity in accordance with a contract (the scheduled or contractual cashflows) and the cash flows that the entity expects to receive (the actual expected cashflows). Given that expected credit losses consider both 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 on an individual exposure level or a collective portfolio level (grouped exposures based on shared credit risk characteristics)
Scope
In IFRS 9 context 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.
Example
There are many alternative ways to estimate expected credit loss, depending on the Credit Portfolio, available data and models. For a more general discussion and the standard formula see Expected Loss. The following example illustrates the concept of probability weighted loss in a modeling framework that adopts three distinct scenarios and assigns to each a probability.
| Scenario Probability | Loss Year 1 | Loss Year 2 | Loss Year 3 | Loss Year 3 | Cumulative Loss | |
|---|---|---|---|---|---|---|
| Scenario 1 | 0.3 | 100 | 50 | 100 | 20 | 270 |
| Scenario 2 | 0.5 | 200 | 100 | 150 | 50 | 500 |
| Scenario 3 | 0.2 | 400 | 200 | 100 | 200 | 900 |
| Probability-Weighted Loss Amount | 210 | 105 | 125 | 71 | 511 |
Issues and Challenges
- Given IFRS 9 is a new standard, there is currently little in terms of established best practise
References
- ↑ IFRS Standard 9, Financial Instruments
