Impairment of loans under the new EU expected loss model
Commission Regulation EU No. 2021/25 of January 13, 2021, which entered into force on January 1, 2022, amended Regulation No. 1126/2008 with the amendments previously introduced on August 27, 2020 in “Interest Rate Benchmark Reform – Phase 2 – Amendments to IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16”, published by the International Accounting Standards Board (IASB). Subsequent changes were made to the general framework of international accounting practices in EU Regulation 2021/1080.
The IASB aimed both to simplify certain processes and to clarify certain practical doubts raised by users regarding the application of international accounting standards.
One of the most significant changes relates to IFRS 9, which provides specific guidance on the recognition of expected credit losses, indicating that an entity should recognise, where appropriate, a provision for expected losses, on the basis of the Expected loss model.
the Expected loss model in IFRS 9 requires that a loan or any amortized financial asset be recorded on the balance sheet with its expected risk of loss, whether the risk has already materialized or will materialize in the future.
Another aspect of the amendment is the new Three-tranche impairment model Where Model LCE. This innovative calculation system classifies loans into three levels which correspond to different methods of calculating potential losses.
The first level is for carry out loans, i.e. exposures which have not shown a significant increase in credit risk or which present a low credit risk at the time of reporting.
The second level is for underperforming loans, ie exposures that have presented a significant increase in credit risk since their initial recognition. Loans or financial instruments fall into this category in the event of default for more than 30 days, downgrading of the rating level or manifest economic or financial distress.
The final ranking is for non-performing loans, ie exposures with objective evidence of loss at the time of reporting, which are identified in accordance with the procedures for accounting for impaired loans. These loans or financial instruments present a significant credit risk which has already manifested itself in an actual loss. A period of more than 90 days without payment would qualify a loan for this level of classification.
These categories are used to assess the expected losses of a loan. At the first level, expected losses are measured over a 12-month period. In the other two levels, where the probability of default is higher, a period of time corresponding to the remaining contractual term (lifetime) or the natural maturity of the loan is assigned. The “life” of a loan, used for level 2 loans, is derived from the presumption that in the event of contractual payment arrears of more than 30 days, the credit risk of the financial asset has increased significantly since initial recognition. However, the debtor entity can rebut this presumption by providing evidence to the contrary in accordance with the “comply or explain” principle, a notion accepted in the field of corporate governance.
The determination of whether credit risk has increased significantly should be based on the most reasonable and enduring information available, without undue cost or effort. This information should include actual and expected changes in external market indicators, internal factors, and borrower-specific information. In addition, the maximum initial credit risk for a given portfolio by product type and/or region (the “initial credit risk”) must be established and compared to the credit risk at the reference date.
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