In response to the recent global shift towards using expected credit loss (ECL) accounting models, the Basel Committee on Banking Supervision has issued guidance for supervisory requirements on sound credit risk practices associated with the implementation and ongoing application of ECL accounting models.
The guidance contains 11 principles on credit risk and accounting for ECLs. It also includes guidance specific to banks applying IFRS, and relating to the new ECL model in IFRS 9 Financial Instruments.
The guidance replaces the previous guidance issued in June 20061.
“We believe that banking supervisors have an important role to play in supporting high-quality, consistent implementation of accounting standards, and that all stakeholders should work together towards this goal.”
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The Committee states that, in its role as a banking supervisor, it expects that internationally active banks will implement ECL accounting frameworks to a high standard. It also discusses how the concepts of proportionality and materiality apply to the guidance.
It emphasises the importance of consistent implementation of the new ECL requirements both within and across jurisdictions. It has noted significant inconsistencies in the way the current incurred loss model was implemented in different jurisdictions, and among banks within the same jurisdiction.
The Committee’s guidance specific to IFRS 9 focuses on:
One of the most difficult judgement areas in implementing IFRS 9’s ECL model is assessing whether credit risk on a financial instrument has increased significantly2. The guidance discusses the Committee’s expectations in this area. For example, it:
The Committee expects that banks will:
Supervisors will give increased scrutiny to any such use, to determine whether it is appropriate.
The guidance recommends that the definition of default used for regulatory purposes should serve as the starting point for banks’ definitions.
It notes that for regulatory purposes, in the case of retail and public sector exposures, some supervisors may allow an indicator of 180 days past due – in place of the standard 90 days – to be used when defining default. However, this should not be read as an exemption from the rebuttable presumption in IFRS 9 that default does not occur later than 90 days past due5.
The guidance notes that the objective of IFRS 9’s impairment model is to deliver fundamental improvements in the measurement of credit losses. Accordingly, the Committee expects banks to develop appropriate systems and processes. It acknowledges that this may require costly up-front investment, but believes that the long-term benefit of this investment far outweighs the cost.
Banks’ IFRS 9 teams should familiarise themselves with the new guidance and consider any possible impact on their implementation plans.
Our latest thinking on this topic can be found in chapter 7A.8 of Insights into IFRS.
Visit our IFRS – Financial instruments hot topics page for the latest developments on the ECL accounting model in IFRS 9.
And visit our IFRS for Banks hot topics page for the latest on IFRS developments that directly impact banks, and the potential accounting implications of regulatory requirements.
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