International Financial Reporting Standards (IFRS) are a set of accounting rules for the financial statements of public companies that are intended to make them consistent, transparent, and easily comparable around the world.

Currently, the set of rules called IFRS9 is used to classify and measure financial assets and financial liabilities. Note that the use of IFRS9 is relevant for all entities. Especially, if they have long-term loans, equity investments, or any non- vanilla financial assets. However, the calculations and implementation of IFRS9 is most complex for financial institutions.

Financial assets should be classified and measured at fair value, with changes in fair value recognized in profit and loss as they arise (“FVPL”), unless restrictive criteria are met for classifying and measuring the asset at either Amortized Cost or Fair Value Through Other Comprehensive Income (“FVOCI”).

In addition to AIRB, which is used for capital calculations, IFRS9 is an important part of credit risk modelling at financial institutions. Loan portfolios meet the criteria to be classified and measured at Amortized Costs. This means that the asset is measured at the amount recognized at initial recognition minus principal repayments and any loss allowance. The loss allowance is defined as expected credit loss (ECL). The ECL should be modelled based on data.

The calculation of ECL depends on the status of the loan. There are three different stages:

  • Stage 1 is used for loans that are not credit impaired and have no significant increase in credit risk since initial recognition. For these loans the 12 months ECL will be used.
  • Stage 2 is used for loans that are not credit impaired. However, these loans have a significant increase in credit risk since initial recognition. For these loans a life-time ECL is used. Credit losses over the full life-time of the loan are considered.
  • Stage 3 is used for loans that are credit impaired. For these loans also a life-time ECL is used. This includes both losses from the current credit impaired period as for potential future credit impaired periods.

For the calculation of ECL, usually a framework that consists of PD, LGD and EAD is used. These components should be made fit for purpose for IFRS9. Most important requirements are:

  • All components should be Point-in-time (PIT). This means that the estimate should reflect the macroeconomic circumstances.
  • Components should be fit-for-purpose for life-time estimates.
  • Discounting should be implemented using Effective Interest Rate (EIR).

These requirements lead to extensive modelling projects. RiskQuest is specialized in these projects. Our role can differ substantially per project: we could support modelling teams at financial institutions, for example by reviewing conceptual frameworks. However, we are also able to fully develop compliant IFRS9 models with our own team. Are you interested in joining this team? You can find our open vacancies here!