Understanding the new expected credit loss framework
IFRS 9 Financial Instruments is an International Financial Reporting Standard published by the International Accounting Standards Board (IASB). It addresses the classification and measurement of financial instruments, including how entities should recognize and measure expected credit losses.
The standard became effective on January 1, 2018, replacing the previous IAS 39 Financial Instruments: Recognition and Measurement. IFRS 9 introduces a more forward-looking approach to credit loss recognition, requiring entities to account for expected credit losses from the moment a financial instrument is recognized.
The 2008 financial crisis revealed significant weaknesses in the incurred loss model under IAS 39. Credit losses were often recognized "too little, too late," which amplified the procyclical effects of the crisis. IFRS 9 addresses these concerns by:
Credit losses are recognized earlier, based on expected rather than incurred losses, providing more timely information to investors.
Requires consideration of forward-looking information, including macroeconomic forecasts and multiple scenarios.
By building provisions during good times, IFRS 9 helps reduce the procyclical cliff effects during economic downturns.
Aligns accounting with credit risk management practices, improving transparency and comparability across entities.
The move from IAS 39 to IFRS 9 represents a fundamental shift in how credit losses are recognized:
| Aspect | IAS 39 (Old) | IFRS 9 (New) |
|---|---|---|
| Loss Recognition | Incurred loss model - losses recognized only when a trigger event occurs | Expected loss model - losses recognized from day one based on expectations |
| Timing | Backward-looking - based on past events | Forward-looking - based on reasonable and supportable forecasts |
| Measurement | Single measurement approach for all assets | Three-stage model based on credit deterioration |
| Information Used | Historical information only | Historical, current, and forward-looking information |
| Interest Revenue | On gross carrying amount | On gross (Stage 1 & 2) or net (Stage 3) carrying amount |
The transition to IFRS 9 typically results in higher credit loss allowances due to the forward-looking ECL model. Banks and financial institutions have reported increases in provisions ranging from 10% to 50% depending on their portfolio composition.
IFRS 9 consists of three main areas:
Financial assets are classified based on the business model for managing them and the contractual cash flow characteristics.
This is our focus. The expected credit loss model for recognizing credit losses on financial assets.
A reformed model that aligns hedge accounting more closely with risk management activities.
This website focuses on the Impairment (ECL) pillar of IFRS 9, which is particularly relevant for banks, lending institutions, and any entity holding debt instruments.
Under IFRS 9, financial assets are categorized into three stages based on credit risk changes since initial recognition:
ECL is the probability-weighted estimate of credit losses over the expected life of a financial instrument. It represents the difference between contractual cash flows due and the cash flows the entity expects to receive, discounted at the original effective interest rate.