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The IFRS 9 expected credit loss (ECL) model requires an entity to recognise impairment on financial assets based on expected, not incurred, losses. Lenders and corporates must classify exposures into three stages, estimate probability of default, loss given default and exposure at default, and adjust for forward looking economic information. In Pakistan, banks apply IFRS 9 under State Bank of Pakistan instructions, and other entities apply it through the Companies Act framework.
Key takeaways
- ECL applies to loans, receivables, contract assets, lease receivables and many guarantees.
- Exposures move between Stage 1, 2 and 3 based on changes in credit risk since initial recognition.
- Forward looking macroeconomic scenarios must be built into the estimate.
- Corporates with trade receivables can often use the simplified approach with a provision matrix.
What are the three stages of the IFRS 9 ECL model?
Stage 1 covers performing exposures, with a 12 month ECL. Stage 2 covers exposures with a significant increase in credit risk since origination, with a lifetime ECL. Stage 3 covers credit impaired exposures, also with a lifetime ECL and interest calculated on the net carrying amount.
How do you decide whether credit risk has increased significantly?
Entities set quantitative and qualitative criteria, such as a change in internal rating, days past due, restructuring or watch list status. IFRS 9 includes a rebuttable presumption that credit risk has increased significantly when payments are more than 30 days past due.
The criteria must be documented, applied consistently and back tested. Auditors focus heavily on how judgement is exercised here.
What data is needed to build an ECL model?
A reliable model needs historical default and recovery data, collateral values, repayment schedules and macroeconomic series such as GDP growth, inflation and interest rates. Data gaps are common in smaller institutions, and proxies must be justified.
- Loan level history of defaults, cures and write offs
- Recovery and collateral realisation records
- Macroeconomic forecasts and scenario weights
- Rating or scoring history for each borrower
How do non financial companies apply ECL to trade receivables?
Corporates can use the simplified approach for trade receivables and contract assets, recognising lifetime ECL from day one. A provision matrix based on ageing buckets and historical loss rates, adjusted for current and forward looking conditions, is usually sufficient.
This is often where we see the biggest audit adjustments in manufacturing and trading groups, because old balances are carried without review.
What disclosures does IFRS 9 ECL require?
IFRS 7 requires disclosure of credit risk management practices, the inputs and assumptions used, reconciliations of loss allowances by stage, and concentrations of credit risk. Good disclosures explain the judgement clearly rather than repeating the standard.
Our financial reporting and IFRS advisory service builds ECL methodologies, documentation and disclosures that withstand audit review.
Written by
Danish Abid, ACA
Founding Partner, Financial Reporting. Over 10 years of external audit experience with Deloitte and Nexia International in Pakistan and Qatar.
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