4.3 Guidelines specific to credit institutions applying IFRS 9

In accordance with paragraph 5.5.5 of IFRS 9, ’if, at the reporting date, the credit risk on a financial instrument has not increased significantly since initial recognition, an entity shall measure the loss allowance for that financial instrument at an amount equal to 12-month expected credit losses’. Credit institutions should measure ECL for all lending exposures and a nil allowance should be rare because ECL estimates are a probability-weighted amount that should always reflect the possibility that a credit loss will occur (see paragraphs 5.5.17 and 5.5.18 of IFRS 9). A nil allowance could however occur, for example, for fully collateralised loans (although credit institutions should be cautious when developing estimates of collateral value, as valuation of collateral at origination may change over the life of the loan).

Credit institutions should adopt an active approach to assessing and measuring 12-month ECL that enables changes in credit risk to be identified in a timely manner and hence the timely recognition of those changes in ECL. In accordance with Principle 6, estimates of the amount and timing of 12-month ECL should reflect senior management’s experienced credit judgement, and represent an unbiased probability-weighted estimate of ECL by considering a range of possible outcomes

IFRS 9 defines an amount equal to 12-month ECL as ‘the portion of lifetime expected credit losses that represent the expected credit losses that result from default events on a financial instrument that are possible within the 12 months after the reporting date’²⁸ . For these purposes, credit institutions must note that an amount equal to the 12-month ECL is not only the losses expected in the next 12 months; rather, in accordance with IFRS 9, paragraph B5.5.43, it is the expected cash shortfalls over the life of the lending exposure or group of lending exposures, due to loss events that could occur in the next 12 months. Credit institutions must also note that, in accordance with IFRS 9, paragraph 5.5.9, to assess whether a financial instrument should move to a lifetime ECL measure, the change in the risk of a default occurring over the expected life of the financial instrument must be considered. In some circumstances, IFRS 9 allows changes in the risk of a default occurring over the next 12 months to be used to make this assessment; however, this may not always be appropriate, and particular attention should be given to the examples set out in IFRS 9, paragraph B5.5.14.

²⁸ See IFRS 9, Appendix A, Defined terms.

IFRS 9, paragraph B5.5.37, does not define default, but requires credit institutions to define default in a manner consistent with that used for internal credit risk management. IFRS 9, paragraph B5.5.37, also includes a rebuttable presumption that default does not occur later than 90 days past due. When adopting a definition of default for accounting purposes, credit institutions should be guided by the definition used for regulatory purposes provided in Article 178 of Regulation (EU) 575/2013²⁹ , which includes both:

• a. a qualitative criterion by which ‘the institution considers that the obligor is unlikely to pay its credit obligations to the institution, the parent undertaking or any of its subsidiaries in full, without recourse by the institution to actions such as realising security’ (‘unlikeliness to pay’ events); and
• b. an objective indicator where ‘the obligor is past due more than 90 days on any material credit obligation to the institution, the parent undertaking or any of its subsidiaries’, equivalent to the rebuttable presumption in IFRS 9, paragraph B5.5.37.

²⁹ The EBA has published draft Guidelines on the application of the definition of default in accordance with Article 178 of Regulation 575/2013.

In accordance with Article 178(1) of Regulation (EU) 575/2013, a default event shall be considered to have occurred with regard to a particular obligor when either of the criteria in paragraphs 4(a) and (b) is met, or both are met. In this context, credit institutions should identify default, in accordance with the ’unlikeliness to pay’ criterion of the debtor, before the exposure becomes delinquent with the 90-days-past-due criterion. In line with the approach followed for regulatory purposes, the list of elements provided in Article 178(3) of Regulation (EU) 575/2013 as indications of unlikeliness to pay should be implemented in a way that ensures a timely detection of ‘unlikeliness to pay’ events that precipitate eventual cash shortfalls. As regards the criterion in paragraph 4(b), although for regulatory purposes in the case of retail and public sector entity obligations, for the 90-day figure competent authorities may substitute a figure of up to 180 days for different products, as it considers appropriate to local conditions (see Article 178(1)(b) of Regulation (EU) 575/2013), this possibility should not be read as an exemption from the application of the 90-day rebuttable presumption in IFRS 9, paragraph B5.5.37, for those exposures.

In formulating the estimate of the amount equal to 12-month ECL, credit institutions should consider reasonable and supportable information, as referred to in the Definitions and in Principle 6 of these guidelines, that affect credit risk, especially forward-looking information, including macroeconomic factors. Credit institutions should exercise experienced credit judgement to consider both qualitative and quantitative information that may affect the credit institution’s assessment of credit risk. IFRS 9 provides that an entity does not need to undertake an exhaustive search for information when measuring an amount equal to 12-month ECL. However, credit institutions should actively incorporate information that may affect the estimate of ECL, and credit institutions should not exclude or ignore relevant information that is reasonably available.

Where a credit institution originates high-credit-risk exposures (which should not be understood, in the context of this paragraph, as meaning the opposite of ‘low credit risk’ exposures as described by IFRS 9, paragraph 5.5.10) and their allowances are initially measured at 12-month ECL, the credit institution should monitor these exposures closely for significant increases in credit risk to ensure a timely movement of the exposure to lifetime ECL measurement, in order to take into account that high risk exposures are likely to exhibit greater volatility and to experience a more rapid increase in credit risk.

Even if an increase in credit risk is not judged to be significant, a credit institution should adjust its estimate of 12-month ECL to appropriately reflect changes in credit risk that have taken place. Such adjustments should be made well before exposures move, either individually or collectively, to lifetime ECL measurement and taking into account any migration of credit risk which has taken place.

Where a collective assessment is performed, exposures within that group should adhere to the requirements set out in Principle 3 of these guidelines. In particular, where information becomes available to the credit institution indicating that further or different segmentation within a group of lending exposures is required, the group should be split into subgroups and the measurement of the amount equal to 12-month ECL should be updated separately for each subgroup or, in the case of transient circumstances, a temporary adjustment should be applied (see Principle 3 of these guidelines and its detailed requirements on the use of temporary adjustments). Where information becomes available which indicates that a particular subgroup has suffered a significant increase in credit risk, then lifetime ECL should be recognised in respect of that subgroup.

Lending exposures should not be grouped in such a way as to obscure the identification of significant increases in credit risk on a timely basis (see also Principles 3 and 4 of these guidelines for additional requirements regarding grouping and collective assessments of ECL).

4.3.2 Assessment of significant increases in credit risk

IFRS 9, paragraph 5.5.4, states that ‘the objective of the impairment requirements is to recognise lifetime expected credit losses for all financial instruments for which there have been significant increases in credit risk since initial recognition — whether assessed on an individual or collective basis — considering all reasonable and supportable information, including that which is forward-looking.’

The rationale for this approach is that the creditworthiness of the counterparty, and thus the ECL anticipated upon initial recognition, is taken into account in the pricing of credit at that time. It follows, then, that a post-origination increase in credit risk may not be fully compensated by the interest rate charged, and, as a consequence, credit institutions should carefully consider whether there has been a significant increase in credit risk³⁰ . If so, the lending exposure should be subject to lifetime ECL measurement.

³⁰ IFRS 9 requires entities to consider a wide range of factors in assessing for significant increases in credit risk, and pricing may be one of those factors.

In order to consider whether an exposure has suffered a significant increase in credit risk and the measurement of required 12-month ECL and lifetime ECL, credit institutions should have in place sound governance, systems and controls, in accordance with the principles specified in these guidelines. Unless already established, credit institutions should implement systems that are capable of handling and systematically assessing the large amounts of information that will be required to judge whether or not particular lending exposures or groups of lending exposures exhibit a significant increase in credit risk, and to measure lifetime ECL where that is the case. Parent undertakings and subsidiaries subject to Directive 2013/36/EU should ensure that the approach is consistent across the group. This should include, in particular, putting in place processes to ensure that forecasts of economic conditions in different jurisdictions and economic sectors are reviewed and approved by a credit institution’s senior management, and that the process, controls and economic assumptions around developing forecasts and linking these to expectations of credit loss are consistent across the group. The need for consistency should not be interpreted as a requirement that the practice be identical across a group. On the contrary, within a consistent framework there may be differences across jurisdictions and products, depending for instance on the availability of data. These differences should be well documented and justified.

Credit institutions’ processes in place should enable them to determine on a timely and holistic basis whether there has been a significant increase in credit risk subsequent to the initial recognition of a lending exposure so that an individual exposure, or a group of exposures with similar credit risk characteristics, is transferred to lifetime ECL measurement as soon as credit risk has increased significantly, in accordance with the IFRS 9 impairment accounting requirements.

As noted in paragraph B5.5.17 of IFRS 9 on assessing significant increases in credit risk since initial recognition, the range of information that will need to be considered in making this determination is wide. In broad terms, it will include information on macroeconomic conditions, and the economic sector and geographical region relevant to a particular borrower or a group of borrowers with shared credit risk characteristics, in addition to borrower-specific strategic, operational and other characteristics. A critical feature is the required consideration of all reasonable and supportable forward-looking information that is available without undue cost and effort (see also paragraph 131 of these guidelines on the information set to be used), in addition to information about current conditions and historical data.

In order to recognise allowances on a timely basis in line with the IFRS 9 requirements, credit institutions should:

• a. assemble data and forward projections for the key drivers of credit risk in their lending exposures and portfolios; and
• b. be able to quantify the credit risk in each of their lending exposures or portfolios based on these data and projections.

IFRS 9, paragraph B5.5.2, states that lifetime expected credit losses are generally expected to be recognised before a financial instrument becomes past due and that ‘typically, credit risk increases significantly before a financial instrument becomes past due or other lagging borrower-specific factors (for example a modification or restructuring) are observed’. Therefore, credit institutions’ analyses should take into account the fact that the determinants of credit losses very often begin to deteriorate a considerable time (months or, in some cases, years) before any objective evidence of delinquency appears in the lending exposures affected. Credit institutions should be mindful that delinquency data are generally backward-looking, and will seldom on their own be appropriate in the implementation of an ECL approach. For example, within retail portfolios adverse developments in macroeconomic factors and borrower attributes will generally lead to an increase in the level of credit risk long before this manifests itself in lagging information such as delinquency.

Thus, in order to meet the objective of IFRS 9 in a robust manner, credit institutions should also consider the linkages between macroeconomic factors and borrower attributes to the level of credit risk in a portfolio based on reasonable and supportable information. To that end, credit institutions should start with a detailed analysis of historical patterns and current trends, which would allow for identification of the most relevant credit risk drivers. Experienced credit judgement should facilitate the incorporation of current and forecasted conditions likely to affect those risk drivers, the expected cash shortfalls and therefore loss expectations.

Credit institutions should perform analyses of this kind not only in the context of portfolios of individually small credits, such as credit card exposures, but also for large, individually managed lending exposures. For example, for a large commercial property loan, credit institutions should take account of the considerable sensitivity of the commercial property market in many jurisdictions to the general macroeconomic environment, and consider using information such as levels of interest rates or vacancy rates to determine whether there has been a significant increase in credit risk.

Credit institutions should have a clear policy including well-developed criteria on what constitutes a ‘significant’ increase in credit risk for different types of lending exposures. Such criteria and the reasons why these approaches and definitions are considered appropriate should be disclosed in accordance with IFRS 7 Financial Instruments: Disclosures , paragraph 35F. IFRS 9, paragraph 5.5.9, requires that, when making the assessment of significant increases in credit risk, ‘an entity shall use the change in the risk of default occurring over the expected life of the financial instrument instead of the change in the amount of expected credit losses’. For these purposes, institutions should make this assessment in terms of the risk of a default occurring and not expected credit loss (i.e. before consideration of the effects of credit risk mitigants such as collateral or guarantees).

In developing their approach to determining a significant increase in credit risk, credit institutions should consider each of the 16 classes of indicators in IFRS 9 (insofar as they are relevant to the financial instrument being assessed) as set out in paragraphs B5.5.17(a)-(p) and, in addition, credit institutions should consider whether there is further information that should be taken into account. Such indicators (in both IFRS 9 and these guidelines) should not be viewed as a ‘checklist’. Some may be more relevant than others to assessing whether a particular type of lending exposure exhibits a significant increase in credit risk. At the same time, credit institutions should take particular care to avoid the risk of a significant increase in credit risk not being acknowledged promptly when it is, in fact, present. In particular, credit institutions should not restrict significant increases in credit risk to situations when a financial instrument is anticipated to become credit impaired (i.e. the third stage of IFRS 9 impairment requirements). Rather, debtors may exhibit a significant increase in credit risk without evidence that the related lending exposures are likely to become impaired. The fact that credit risk has increased significantly does not necessarily mean that default is probable — merely that it is more likely than at initial recognition. This point is underlined by the symmetry of the IFRS 9 model: it is possible for lending exposures to move to lifetime ECL but subsequently be moved back to 12-month ECL if the threshold of a significant increase in credit risk is no longer met.

Credit institutions should consider in particular the following non-exhaustive list of indicators in assessing a significant increase in credit risk:

• a. a decision by the credit institution’s senior management such that, if an existing lending exposure were newly originated at the reporting date, the element of the price of the lending exposure that reflects the credit risk of the exposure would be significantly higher than it was when the loan was actually originated, because of an increase in the credit risk of the specific borrower or class of borrowers since inception;
• b. a decision by the credit institution’s senior management to strengthen collateral and/or covenant requirements for new lending exposures that are similar to lending exposures already originated, because of changes in the credit risk of those exposures since initial recognition;
• c. a downgrade of a borrower by a recognised credit rating agency, or within a credit institution’s internal credit rating system;
• d. for performing lending exposures subject to individual monitoring and review, an internal credit assessment summary/credit-quality indicator that is weaker than upon initial recognition;
• e. deterioration of relevant determinants of credit risk (e.g. future cash flows) for an individual obligor (or pool of obligors); and
• f. expectation of modification due to financial difficulties, including those qualifying as forbearance in accordance with Regulation (EU) 2015/227.

While implementation of IFRS 9 should reflect credit risk management practices where possible, in some cases that would not be appropriate. If, for example, a credit institution manages most lending exposures in the same way regardless of credit risk — with the exception only of particularly strong or weak credits — the manner in which a lending exposure is managed is unlikely to be a sound indicator of whether there has been a significant increase in credit risk.

When assessing whether there has been a significant increase in credit risk for a lending exposure, credit institutions should also take into account the following factors which are related to the environment in which a credit institution or the borrower operates:

• a. deterioration of the macroeconomic outlook relevant to a particular borrower or to a group of borrowers. Macroeconomic assessments should be sufficiently rich to include factors relevant to sovereign, corporate, household and other types of borrower. Furthermore, they should address any relevant regional differences in economic performance within a jurisdiction³¹ ; and
• b. deterioration of prospects for the sector or industries within which a borrower operates.

³¹ See Principle 6 of these guidelines on the consideration of forward-looking information, including macroeconomic factors.

Accurate identification of drivers of credit risk, and reliable demonstration of the linkages between those drivers and the level of credit risk, should be considered as critical, as a seemingly small change in a qualitative characteristic of a loan can potentially be a leading indicator of a large increase in the risk of a default occurring. Furthermore, in accordance with IFRS 9, paragraph 5.5.9, the significance of a change in credit risk since initial recognition depends on the risk of a default occurring at initial recognition. In this regard, where a credit institution uses changes in PD as a means of identifying changes in the risk of a default occurring, it should take into consideration the significance of a given change in PD expressed in a ratio (or the rate of fluctuation) proportionate to the PD at initial recognition (i.e. a change in the PD divided by the PD at initial recognition), considering also paragraph B5.5.11 of IFRS 9. However, the width of the change in PD itself (i.e. PD at measurement date minus PD at initial recognition) should also be taken into consideration.

Credit institutions should look beyond how many ‘grades’ a rating downgrade entails because the change in PD for a one-grade movement may not be linear (for example, the default probability over five years of an exposure rated BB is around three times that of one rated BBB, based on current data and analyses applicable to certain jurisdictions). Furthermore, because the significance of a one-grade movement would depend on the granularity of a bank’s rating system — and hence the ‘width’ of each grade — an appropriate initial segmentation should be defined to ensure that a significant increase in credit risk for an individual lending exposure or a group of lending exposures is not obscured within a segment. In this regard, credit institutions should ensure that credit risk rating systems include a sufficient number of grades to appropriately distinguish credit risk. Credit institutions should also be mindful of the fact that a significant increase in credit risk could occur prior to a movement in a credit grade.

Credit institutions should take into account that there are some circumstances in which an adverse movement in the factors listed in paragraphs 107 and 108 above might not be indicative of a significant increase in credit risk. For example, it may be the case that the default probability of a lending exposure rated AA is low, and not much greater than one rated AAA. However, very few lending exposures are of such apparently low credit risk — and, as noted in paragraph 110, the sensitivity of default probability to rating grades may increase strongly as rating quality declines.

Credit institutions should also be aware that there could be circumstances in which some factors move in an adverse direction but may be counterbalanced by improvement in others (see IFRS 9 Implementation Guidance, Example 2). Nonetheless, in view of the importance of detecting whether there has been a significant increase in credit risk, credit institutions should put in place governance and control processes capable of reliably validating any judgement that factors which may have an adverse impact on credit risk are counterbalanced by factors which may have a favourable impact.

Credit institutions should give thorough consideration and full weight to discretionary decisions by a credit institution’s management body or senior management which point to a change in credit risk. For example, if because of concerns about credit risk a decision is made to intensify the monitoring of a borrower or class of borrowers, it is unlikely that such action would have been taken by the decision-maker had the increase in credit risk not been perceived as significant.

When a credit institution assesses that there has been a significant increase in credit risk for some, but not all, of its lending exposures to a counterparty — for example, because of differences in the timing of when lending was provided — it should ensure that all lending exposures are identified where there has been a significant increase in credit risk.

Where a credit institution makes the assessment of significant increases in credit risk on a collective basis (i.e. such as retail), the definitions of portfolios should be reviewed regularly to ensure that the lending exposures within them continue to share risk characteristics in terms of their response to credit risk drivers. Changing economic conditions may require regrouping.

In line with paragraph B5.5.1 of IFRS 9 on the assessment of significant increases in credit risk since initial recognition on a collective basis, in instances where it is apparent that, within a group of lending exposures, some lending exposures have experienced a significant increase in credit risk, credit institutions should transfer a subset or a proportion of the group of lending exposures to lifetime ECL measurement even though it is not possible to identify this on an individual lending exposure basis (see IFRS 9, Illustrative Example 5).

Consistent with paragraph B5.5.6 of IFRS 9 and paragraph IE39 of the Implementation Guidance for IFRS 9, if it is not possible on the basis of shared credit risk characteristics to identify a particular subgroup of lending exposures for which credit risk has increased significantly, an appropriate proportion of the overall group should be subject to lifetime ECL measurement.

‘Significant’ should not be equated with statistical significance, meaning that the assessment approach should not be based solely on quantitative analysis. For portfolios which have a large number of individually small credits, and a rich set of relevant historical data, it may be possible to identify ‘significant’ increases in credit risk in part by using statistical techniques. However, for other lending exposures, that may not be feasible.

‘Significant’ should also not be judged in terms of the extent of impact on a credit institution’s primary financial statements. Identification and disclosure of significant increases in credit risk should be undertaken, even where an increase in credit risk defined in terms of probability of default is unlikely to affect the allowance made — for example, because the exposure is more than fully collateralised — to allow credit institutions to identify and disclose such increases which are likely to be important to users seeking to understand trends in the intrinsic credit risk of a credit institution’s lending exposures.

In accordance with IFRS 9, paragraph 5.5.9, the assessment of significant increases in credit risk is based on comparing credit risk on exposures at the reporting date relative to credit risk upon initial recognition. IFRS 9, paragraph BC 5.161, and Illustrative Example 6 represent an example of the application of this principle in the Standard, rather than an exception to that principle. This example suggests that credit institutions can set a maximum credit risk for particular portfolios upon initial recognition that would lead to that portfolio moving to lifetime ECL measurement when credit risk increases beyond that maximum level. This simplification is only relevant when exposures are segmented on a sufficiently granular basis such that a credit institution can demonstrate that the analysis is consistent with the principles of IFRS 9. Specifically, credit institutions should be able to demonstrate that a significant increase in credit risk had not occurred for items in the portfolio before the maximum credit grade was reached.

Credit institutions should rigorously review the quality of their approach to assessing whether credit risk has increased significantly. A credit institution’s management body or senior management should consider whether there are additional factors that should be taken into account in the assessment of significant increases in credit risk which would improve the quality of their approach.

Credit institutions should be alert to any possibility of bias being introduced that would prevent the objectives of IFRS 9 from being met. In cases where credit institutions believe that their approach to implementation is likely to have introduced bias, they should change their assessment for identified bias and thus ensure that the objective of the Standard is met (see in particular IFRS 9, paragraphs B5.5.1-B5.5.6).

IFRS 9, in paragraphs 5.5.12 and B5.5.25-B5.5.27, sets out the requirements for the assessment of significant increases in credit risk for lending exposures whose contractual cash flows have been renegotiated or modified. In particular, for modifications that do not result in derecognition in accordance with IFRS 9, an entity must assess whether credit risk has increased significantly by comparing (a) the risk of a default occurring at the reporting date based on the modified contractual terms with (b) the risk of default occurring upon initial recognition based on the original, unmodified contractual terms.

Credit institutions should ensure that modifications or renegotiations do not obscure increases in credit risk and thereby cause ECL to be underestimated and to delay the transfer to lifetime ECL for obligors whose credit risk has significantly deteriorated, or inappropriately result in a move from lifetime ECL measurement back to 12-month ECL measurement.

When determining whether there is a significant increase in credit risk for a modified lending exposure, credit institutions should be able to demonstrate, and should take into account when developing ECL estimates, whether such modifications or renegotiations have improved or restored the ability of the credit institution to collect interest and principal payments compared with the situation upon initial recognition. Consideration should also be given to the substance of modified contractual cash flows as well as the implications of the modifications for the future credit risk of the lending exposure (taking into consideration the obligor’s credit risk). Factors to consider include, but are not limited to, the following:

• a. whether the modification or renegotiation of the contractual terms and resulting cash flows is economically beneficial to the obligor, compared with the original, unmodified contractual terms, and how the modification economically affects the obligor’s ability to repay the debt;
• b. whether factors can be identified that support a credit institution’s assessment of the obligor’s ability to repay the debt, including circumstances leading up to the modification, and future prospects of the obligor as a result of the modifications, considering current conditions, macroeconomic forecasts, and prospects for the sector/industry within which the obligor operates, the obligor’s business model, and the obligor’s business (management) plan that outlines the obligor’s expectations of its future performance, financial resilience and cash flows; and
• c. whether the obligor’s business plan is feasible, realisable and consistent with the repayment schedule of interest and principal under the modified contractual terms of the lending exposure.

Lending exposures transferred to lifetime ECL that are subsequently renegotiated or modified, and not derecognised, should not move back to 12-month ECL measurement unless there is sufficient evidence that the credit risk over the life of the exposure has not increased significantly compared with that upon initial recognition. For example, where a credit institution grants various concessions such as interest rate reductions or postponements of principal repayments to obligors in financial difficulty, the lending exposure may exhibit characteristics of a lower credit risk even though in reality the obligor may continue to experience financial difficulty with no realistic prospects of making scheduled repayments over the remaining term of the exposure. In accordance with paragraph B5.5.27 of IFRS 9 ‘evidence that the criteria for the recognition of lifetime ECL are no longer met could include a history of up-to-date and timely payment performance against the modified contractual terms. Typically, a customer would need to demonstrate consistently good payment behaviour over a period of time before the credit risk is considered to have decreased. For example, a history of missed or incomplete payments would not typically be erased by simply making one payment on time following a modification of the contractual terms’.

4.3.3 Use of practical expedients

IFRS 9 includes a number of practical expedients, intended to ease the implementation burden for a wide range of companies in recognition of the fact that IFRS 9 will be used by a variety of entities, including entities outside the banking industry.

The paragraphs below address the following practical expedients: the information set which an entity must consider in measuring ECL; the exception for ‘low’ credit risk exposures; and the 30-days-past-due rebuttable presumption.

Credit institutions should make limited use of those practical expedients as they have the potential to introduce significant bias and because — given their business — the cost of obtaining the relevant information is not likely to involve ‘undue cost or effort’. Credit institutions should consider the need to make adjustments when using practical expedients to avoid any resulting bias, as they should take into account that the objective of IFRS 9 is to estimate expected credit losses to reflect an unbiased and probability-weighted amount that is determined by evaluating a range of possible outcomes (IFRS 9, paragraph 5.5.17).

Where a credit institution uses such practical expedients, justifications for the use of practical expedients should be clearly documented by the credit institution. The information set

IFRS 9, paragraph B5.5.15, states that ´an entity shall consider reasonable and supportable information that is available without undue cost and effort´ and that ‘an entity need not undertake an exhaustive search for information when determining whether credit risk has increased significantly since initial recognition’. Credit institutions should not read these statements restrictively and should develop systems and processes that use all reasonable and supportable information that is relevant to the group of exposures or individual exposure, as needed to achieve a high-quality, robust and consistent implementation of the accounting requirements. Nevertheless, additional cost and operational burden do not need to be introduced where they do not contribute to a high-quality implementation of IFRS 9.

‘Low credit risk’ exemption

In accordance with paragraph 5.5.10 of IFRS 9, ´an entity may assume that the credit risk on a financial instrument has not increased significantly since initial recognition if the financial instrument is determined to have a low credit risk at the reporting date´. Although credit institutions thus have the option for ‘low credit risk’ exposures not to assess whether credit risk has increased significantly since initial recognition, use of this exemption should be limited. In particular, credit institutions should conduct timely assessment of significant increases in credit risk for all lending exposures.

In that context, credit institutions should always recognise changes in 12-month ECL through the allowance where there is not a significant increase in credit risk and move lending exposures to lifetime ECL measurement, if there is a significant increase in credit risk. In order to achieve a high-quality implementation of IFRS 9, any use of the low-credit-risk exemption should be accompanied by clear evidence that credit risk as of the reporting date is sufficiently low that a significant increase in credit risk since initial recognition could not have occurred.

To illustrate the meaning of low credit risk in IFRS 9, paragraph B5.5.22, IFRS 9, paragraph B5.5.23, cites as an example an instrument with an external ‘investment grade’ rating. However, all lending exposures that have an ‘investment grade’ rating from a credit rating agency cannot automatically be considered low credit risk. Credit institutions should rely primarily on their own credit risk assessments in order to evaluate the credit risk of a lending exposure, and not rely solely or mechanistically on ratings provided by credit rating agencies (where the latter are available). Nevertheless, optimistic internal credit ratings, as compared with external ratings, should require additional analysis and justification by a credit institution’s management body or senior management.

More-than-30-days-past-due rebuttable presumption

Credit institutions should have credit risk assessment and management processes in place to ensure that significant credit risk increases are detected well ahead of exposures becoming past due or delinquent. Although the use of the more-than-30-days-past-due rebuttable presumption as a backstop measure is not precluded in accordance with IFRS 9 alongside other, earlier indicators for assessing significant increase in credit risk, credit institutions should avoid using it as a primary indicator of transfer to lifetime ECL.

Any assertion that the more-than-30-days-past-due presumption is rebutted on the basis that there has not been a significant increase in credit risk should be accompanied by a thorough analysis clearly demonstrating that 30 days past due is not correlated with a significant increase in credit risk³² . Such analysis should consider both current and reasonable and supportable forward-looking information that may cause future cash shortfalls to differ from historical experience.

³² For example, in some jurisdictions it is common practice for borrowers to delay repayment for certain exposures, but history shows that those missed payments are fully recouped in the succeeding months.

In this regard, credit institutions should use relevant forward-looking information that is reasonable and supportable to analyse whether there is any substantive relationship between such information and credit risk drivers. Credit institutions should not use the 30-days-past-due rebuttable presumption unless they have demonstrated that the forward-looking information had no substantive relationship with the credit risk driver or such information is not available without undue cost or effort.

In the limited instances where past-due information is the best criterion available to a credit institution to determine when exposures should move to the lifetime ECL category, credit institutions should pay particular attention to their measurement of 12-month ECL allowance to ensure that ECL are appropriately captured in accordance with the measurement objective of IFRS 9. Moreover, credit institutions should take into account that significant reliance on backward-looking information will introduce bias into the implementation of an ECL accounting model and that they should ensure that the objectives of the IFRS 9 impairment requirements (i.e. to reflect ECL that meet the stated measurement objectives and to capture all significant increases in credit risk) are met.