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Time is running out. Banks that report under Changes in Classification and
IFRSs must apply IFRS 9 Financial Instruments Measurement
in their 2018 financial statements. To be
ready, banks must complete a large multi- t The classification categories for
disciplinary project combining the skills of financial assets under IAS 39 of held to
finance, risk and IT. The project will require maturity, loans and receivables, FVTPL,
13 EXPERTS CORNER THE KOSOVO BANKER | JULY 2017
t Expected credit losses (ECLs) are Credit losses are defined as the difference
recognized at each reporting period, between all the contractual cash flows that
even if no actual loss events have taken are due to an entity and the cash flows
place. that it actually expects to receive (‘cash
t In addition to past events and current shortfalls’). This difference is discounted
conditions, reasonable and supportable at the original effective interest rate (or
forward-looking information that is credit-adjusted effective interest rate for
available without undue cost or effort is purchased or originated credit-impaired
considered in determining impairment. financial assets).
t The model will be applied to all financial
instruments subject to impairment
testing. What are ‘12-month expected
credit losses’?
financial instrument. An asset moves from about its credit risk, it may not be possible
12-month expected credit losses to lifetime to identify significant changes in credit
expected credit losses when there has risk at individual instrument level before
been a significant deterioration in credit the financial instrument becomes past
quality since initial recognition. Hence the due. It may therefore be necessary to
‘boundary’ between 12-month and lifetime assess significant increases in credit risk
losses is based on the change in credit risk on a collective or portfolio basis. This is
not the absolute level of risk at the reporting particularly relevant to financial institutions
date. with a large number of relatively small
exposures such as retail loans. In practice,
Finally, it is possible for an instrument for the lender may not obtain or monitor
which lifetime expected credit losses have forward-looking credit information about
been recognized to revert to 12-month each customer. In such cases the lender
expected credit losses should the credit risk would assess changes in credit risk for
of the instrument subsequently improve appropriate portfolios, groups of portfolios
so that the requirement for recognizing or portions of a portfolio of financial
lifetime expected credit losses is no longer instruments. Any instruments that are
met. assessed collectively must possess shared
credit risk characteristics. This is to prevent
significant increases in credit risk being
What is the definition of “default” obscured by aggregating instruments that
have different risks. When instruments
IFRS 9 explains that changes in credit risk are assessed collectively, it is important to
are assessed based on changes in the risk remember that the aggregation may need
of a default occurring over the expected life to change over time as new information
of the financial instrument (the assessment becomes available.
is not based on the amount of expected
losses). ‘Default’ is not itself actually
defined in IFRS 9 however. Banks must Collateral
instead reach their own definition and IFRS
9 provides guidance on how to do this. The While the existence of collateral plays
Standard states that when defining default, a limited role in the assessment of
an entity shall apply a default definition that whether there has been a significant
is consistent with the definition used for increase in credit risk, it is very relevant
internal credit risk management purposes to the measurement of expected credit
for the relevant financial instrument losses. IFRS 9 states that the estimate of
and consider qualitative indicators (for expected cash shortfalls reflects the cash
example, financial covenants) when flows expected from collateral and other
appropriate. However, there is a ‘rebuttable credit enhancements that are integral to
presumption’ that default does not occur the instrument’s contractual terms. The
later than when a financial asset is 90 days estimate of expected cash shortfalls on a
past due unless an entity has reasonable and collateralized financial instrument reflects:
supportable information to demonstrate
that a more lagging default criterion is t the amount and timing of cash flows
more appropriate. that are expected from foreclosure on
the collateral
t less the costs of obtaining and selling
Individual or collective the collateral.
assessment for impairment
This is irrespective of whether or not
Depending on the nature of the financial foreclosure is probable. In other words, the
instrument and the information available estimate of expected cash flows considers
both the probability of a foreclosure and the
THE KOSOVO BANKER | JULY 2017 EXPERTS CORNER 16
cash flows that would result from it. t explanation of gross carrying amounts
A consequence of this is that any cash flows showing key drivers for change
that are expected from the realization of the t gross carrying amount per credit risk
collateral beyond the contractual maturity grade or delinquency
of the contract are included in the analysis. t write-offs, recoveries and modifications
This is not to say that the entity is required t quantitative information about the
to assume that recovery will be through collateral held as security and other
foreclosure only however. Instead the entity credit enhancements for credit-
should calculate the cash flows arising impaired assets.
from the various ways in which the asset
might be recovered and assign probability- To conclude, the classification and
weightings to those outcomes. measurement based on IFRS 9 rules
will achieve increased comparability
internationally in the accounting for financial
Key Disclosures instruments and paint a fairer picture of
the entity’s unique risk management policy
The disclosures added to IFRS 7 are intended and strategy.
to enable users of the financial statements
to understand the effect of credit risk on
the amount, timing and uncertainty of
future cash flows.
Qualitative disclosures
Quantitative disclosures