International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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deterioration has occurred because market prices are also affected by non-credit risk
related factors such as changes in interest rates or liquidity risks; [IFRS 9.BC5.123]
• an actual or expected significant change in the financial instrument’s external
credit rating;
• an actual or expected internal credit rating downgrade for the borrower or
decrease in behavioural scoring used to assess credit risk internally. Internal credit
ratings and internal behavioural scoring are more reliable when they are mapped
to external ratings or supported by default studies;
• existing or forecast adverse changes in business, financial or economic conditions
that are expected to cause a significant change in the borrower’s ability to meet its
debt obligations, such as an actual or expected increase in interest rates or an actual
or expected significant increase in unemployment rates;
• an actual or expected significant change in the operating results of the borrower.
Examples include actual or expected declining revenues or margins, increasing
operating risks, working capital deficiencies, decreasing asset quality, increased balance
sheet leverage, liquidity, management problems or changes in the scope of business or
organisational structure (such as the discontinuance of a segment of the business) that
result in a significant change in the borrower’s ability to meet its debt obligations;
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• significant increases in credit risk on other financial instruments of the same borrower;
• an actual or expected significant adverse change in the regulatory, economic, or
technological environment of the borrower that results in a significant change in
the borrower’s ability to meet its debt obligations, such as a decline in the demand
for the borrower’s sales product because of a shift in technology;
• significant changes in the value of the collateral supporting the obligation or in the
quality of third-party guarantees or credit enhancements, which are expected to
reduce the borrower’s economic incentive to make scheduled contractual
payments or to otherwise have an effect on the risk of a default occurring. For
example, if the value of collateral declines because house prices decline, borrowers
in some jurisdictions have a greater incentive to default on their mortgages;
• a significant change in the quality of the guarantee provided by a shareholder (or
an individual’s parents) if the shareholder (or parents) have an incentive and
financial ability to prevent default by capital or cash infusion;
• significant changes, such as reductions, in financial support from a parent entity or
other affiliate or an actual or expected significant change in the quality of credit
enhancement, that are expected to reduce the borrower’s economic incentive to
make scheduled contractual payments. For example, such a situation could occur if a
parent decides to no longer provide financial support to a subsidiary, which as a result
would face bankruptcy or receivership. This could in turn result in that subsidiary
prioritising payments for its operational needs (such as payroll and crucial suppliers)
and assigning a lower priority to payments on its financial debt, resulting in an increase
in the risk of default on those liabilities. Credit quality enhancements or support
include the consideration of the financial condition of the guarantor and/or, for
interests issued in securitisations, whether subordinated interests are expected to be
capable of absorbing ECLs (for example, on the loans underlying the security);
• expected changes in the loan documentation (i.e. changes in contract terms) including
an expected breach of contract that may lead to covenant waivers or amendments,
interest payment holidays, interest rate step-ups, requiring additional collateral or
guarantees, or other changes to the contractual framework of the instrument;
• significant changes in the expected performance and behaviour of the borrower,
including changes in the payment status of borrowers in the group (for example,
an increase in the expected number or extent of delayed contractual payments or
significant increases in the expected number of credit card borrowers who are
expected to approach or exceed their credit limit or who are expected to be paying
the minimum monthly amount);
• changes in the entity’s credit management approach in relation to the financial
instrument, i.e. based on emerging indicators of changes in the credit risk of the
financial instrument, the entity’s credit risk management practice is expected to
become more active or to be focused on managing the instrument, including the
instrument becoming more closely monitored or controlled, or the entity
specifically intervening with the borrower; and
• past due information, including the more than 30 days past due rebuttable
presumption (see 6.2.2 below).
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We make the following observations:
• If entities make the staging assessment using their credit risk management systems,
they will need to consider whether their systems take into account the various
indicators listed above.
• Many financial institutions should have readily available information about the
pricing and terms of various types of loans issued to a specific customer (e.g.
overdraft, credit cards and mortgage loans) in their credit risk management systems
and processes. However, in practice, it would often be difficult to use such
information because changes in pricing and terms on the origination of a similar
financial instrument at the reporting date may not be so obviously related to a
change in credit risk as other, more commercial, factors come into play (e.g.
different risk appetites, change in management approach and underwriting
standards). It may be challenging to link the two sets of information (i.e. pricing
processes on the one hand and credit risk management on the other).
• Some collateralised loans are subject to cash variation margining requirements,
which means that the trigger for default is normally the inability to pay a margin call.
Therefore, in such circumstances the PD may be driven by the value of the collateral
and changes in collateral values may need to be reflected in the staging assessment.
• Some of the factors or indicators are only relevant for the assessment of significant
deterioration on an individual basis and not on a portfolio basis. For example, change
in external market indicators of credit risk, including the credit spread, the credit
default swap prices of the borrower and the extent of decline in fair value. However,
it is worth noting that external market information that is available for a quoted
instrument may be useful to help assess another instrument that is not quoted but
which is issued by the same debtor or one who operates in the same sector.
• It is important to stress that the approach required by the standard is more holistic
and qualitative than is necessarily captured by external credit ratings, which are
adjusted for discrete events and may not reflect gradual degradations in credit quality.
External credit ratings should not, therefore, be used on their own but only in
forward-looking, it is sometimes suggested that changes in credit ratings may not be
reflected in a timely matter. Therefore, entities may have to take account of expected
change in ratings in assessing whether exposures are low risk. (Example 47.12 below
illustrates that there could be significant differences between using agencies’ credit
ratings or using market data such as CDS spreads). The same point can of course be
made about the use of internal credit ratings, especially if they are only reassessed on
an annual basis. At the September 2015 meeting, the ITG observed that credit grading
systems were not designed with the requirements of IFRS 9 in mind, and thus it
should not be assumed that they will always be an appropriate means of identifying
significant increases in credit risk. The appropriateness of using internal credit grading
systems as a means of assessing changes in credit risk since initial recognition depends
on whether the credit grades are reviewed with sufficient frequency, include all
reasonable and supportable information and reflect the risk of default over the
expected life of the financial instrument.
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• As credit grading systems vary, care needs to be taken when referring to movements
in credit grades and how this reflects an increased risk of default occurring. In
addition, the assessment of whether a change in credit risk grade represents a
significant increase in credit risk in accordance with IFRS 9 depends on the initial
credit risk of the financial instrument being assessed. Moreover, the relationship
between credit grades and changes in the risk of default occurring differs between
credit grading systems. For instance, in some cases the changes in the risk of a default
occurring may increase exponentially between grades whereas in others it may not.
• Also, some of the above factors or indicators are very forward-looking, such as
forecasts of adverse changes in business, financial or economic conditions that are
expected to result in significant future financial difficulty of the borrower in
repaying its debt. In practice, the analysis may have to be performed at the level of
a portfolio rather than at an individual level when forward-looking information is
not available at the individual level.
With IFRS 9 not being prescriptive, we observe differences in how banks have
implemented the assessment of significant increase in credit risk. These differences
reflect various schools of thought along with differences in credit processes, business
model, sophistication, use of advanced models for regulatory capital purposes,
availability of data (e.g. historic data at origination) and consistency of definitions across
businesses or multiple systems. As use of models and availability of data can vary within
a bank, a number of approaches may even be adopted within a single institution.
In general, banks use a combination of quantitative and qualitative drivers to assess
significant increases in credit risk. Some of these are regarded as primary, others as
secondary and some as backstops. The primary driver is usually expected to be the most
forward looking indicator and is generally based on a relative measure. The most
common primary drivers used by the larger banks are:
• changes in the lifetime risk of a default occurring, guided by scores and ratings;
• changes in the lifetime or 12-month probability of default; or
• changes in ratings or credit scores for retail exposures and ratings for corporate
exposures.
Forbearance and watchlists are often used as secondary drivers and delinquency,
usually 30 days past due as a backstop (see 6.2.2 below).
6.2.2
Past due status and more than 30 days past due rebuttable presumption
The IASB is concerned that past due information is a lagging indicator. Typically, credit
risk increases significantly before a financial instrument becomes past due or other
lagging borrower-specific factors (for example, a modification or restructuring) are
observed. Consequently, when reasonable and supportable information that is more
forward-looking than past due information is available without undue cost or effort, it
must be used to assess changes in credit risk and an entity cannot rely solely on past due
information. [IFRS 9.5.5.11, B5.5.2]. However, the IASB acknowledged that many entities
manage credit risk on the basis of information about past due status and have a limited
ability to assess credit risk on an instrument-by-instrument basis in more detail on a
timely basis. [IFRS 9.BC5.192]. Therefore, if more forward-looking information (either on
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an individual or collective basis) is not available without undue cost or effort, an entity
may use past due information to assess changes in credit risks. [IFRS 9.5.5.11].
Whether the entity uses only past due information or also more forward looking
information (e.g. macroeconomic indicators), there is a rebuttable presumption that the
credit risk on a financial asset has increased significantly since initial recognition when
contractual payments are more than 30 days past due. However, the standard seems to
make it clear that it is not possible to rebut the 30 days past due presumption just because
of a favourable economic outlook. [IFRS 9.5.5.11, B5.5.19]. The IASB decided that this rebuttable
presumption was required to ensure that application of the assessment of the increase in
credit risk does not result in a reversion to an incurred loss notion. [IFRS 9.BC5.190].
Moreover, as already stressed earlier, the standard is clear that an entity cannot align
the definition and criteria used to identify significant increases in credit risk (and the
resulting recognition of lifetime ECLs) to when a financial asset is regarded as credit-
impaired or to an entity’s internal definition of default. [IFRS 9.B5.5.21]. An entity should
normally identify significant increases in credit risk and recognise lifetime ECLs before
default occurs or the financial asset becomes credit-impaired, either on an individual or
collective basis (see 6.5 below).
An entity can rebut the 30 days past due presumption if it has reasonable and supportable
information that is available without undue cost or effort, that demonstrates that credit
risk has not increased significantly even though contractual payments are more than
30 days past due. [IFRS 9.5.5.11]. Such evidence may include, for example, knowledge that a
missed non-payment is because of administrative oversight rather than financial difficulty
of the borrower, or historical information that suggests significant increases in credit risks
only occur when payments are more than 60 days past due. [IFRS 9.B5.5.20].
6.2.3
Illustrative examples of factors or indicators when assessing
significant increases in credit risk
The consideration of various factors or indicators when assessing significant increases
in credit risk since initial recognition is illustrated in Examples 47.8 and 47.9, which are
based on Examples 1 and 2 in the Implementation Guidance for the standard.
[IFRS 9 IG Example 1 IE7-IE11, IG Example 2 IE12-IE17].
Exam
ple 47.8: Significant increase in credit risk
Company Y has a funding structure that includes a senior secured loan facility with different tranches. The
security on the loan affects the loss that would be realised if a default occurs, but does not affect the risk of a
default occurring, so it is not considered when determining whether there has been a significant increase in credit
risk since initial recognition as required by paragraph 5.5.3 of IFRS 9. Bank X provides a tranche of that loan
facility to Company Y. At the time of origination of the loan by Bank X, although Company Y’s leverage was
relatively high compared with other issuers with similar credit risk, it was expected that Company Y would be
able to meet the covenants for the life of the instrument. In addition, the generation of revenue and cash flow
was expected to be stable in Company Y’s industry over the term of the senior facility. However, there was some
business risk related to the ability to grow gross margins within its existing businesses.
At initial recognition, because of the considerations outlined above, Bank X considers that despite the level
of credit risk at initial recognition, the loan is not an originated credit-impaired loan because it does not meet
the definition of a credit-impaired financial asset in Appendix A of IFRS 9.
Subsequent to initial recognition, macroeconomic changes have had a negative effect on total sales volume and
Company Y has underperformed on its business plan for revenue generation and net cash flow generation.
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Although spending on inventory has increased, anticipated sales have not materialised. To increase liquidity,
Company Y has drawn down more on a separate revolving credit facility, thereby increasing its leverage ratio.
Consequently, Company Y is now close to breaching its covenants on the senior secured loan facility with Bank X.
Bank X makes an overall assessment of the credit risk on the loan to Company Y at the reporting date, by
taking into consideration all reasonable and supportable information that is available without undue cost or
effort and that is relevant for assessing the extent of the increase in credit risk since initial recognition. This
may include factors such as:
(a) Bank X’s expectation that the deterioration in the macroeconomic environment may continue in the near