Last update 28/12/2019
Individual or collective assessment for impairment – An entity should normally identify significant increases in credit risk and recognise lifetime Expected Credit Losses (ECL) before default occurs or the financial asset becomes credit-impaired, either on an individual or collective basis. Individual or collective assessment for impairment
It may not be practical to determine for every financial instrument whether there has been a significant increase in credit risk, because they may be small and many in number and because the evidence may not be available to do so. Consequently, it may be necessary to assess ECLs on a collective basis, to approximate the result of using comprehensive credit risk information that incorporates forward-looking information at an individual instrument level. Individual or collective assessment for impairment
Collective assessment
Most lenders of loans to corporate borrowers will possess much of the forward looking information at an individual borrower level and may already be including it in their risk assessments. However, compliance with the standard may require that this information is updated more often than may currently be the case. In contrast, most lenders to retail borrowers will not have this kind of information at the individual borrower level and will much more likely need to make use of a collective assessment. Individual or collective assessment for impairment
Banks have hundreds of thousands, or even millions, of small exposures to retail customers and small businesses, for which they do not receive sufficient information to monitor the individual credit quality, beyond whether any payments are past due, and for which it would be impractical to reassess individually even if they possessed more data. Instead, they manage these exposures on an aggregated basis, combining past due data with historical statistical experience and sometimes macroeconomic indicators, such as interest rates and unemployment levels, that tend to correlate with future defaults. Individual or collective assessment for impairment
Individual assessment
Example: The bank assesses each of its mortgage loans on a monthly basis by means of an automated behavioural scoring process based on current and historical past due statuses, levels of customer indebtedness, loan-to-value (LTV) measures, customer behaviour on other financial instruments with the bank, the loan size and the time since the origination of the loan. It is said that historical data indicates a strong correlation between the value of residential property and the default rates for mortgages. Individual or collective assessment for impairment
The bank updates the LTV measures on a regular basis through an automated process that re-estimates property values using recent sales in each post code area and reasonable and supportable forward-looking information that is available without undue cost or effort. Therefore, an increased risk of a default occurring due to an expected decline in residential property value adjusts the behavioural scores and the bank is therefore able to identify significant increases in credit risk of individual customers before a mortgage becomes past due if there has been a deterioration in the behavioural score. Individual or collective assessment for impairment
The example concludes that if the bank was unable to update behavioural scores to reflect the expected declines in property prices, it would use reasonable and supportable information that is available without undue cost or effort to undertake a collective assessment to determine the loans on which there has been a significant increase in credit risk since initial recognition and recognize lifetime ECLs for those loans. Individual or collective assessment for impairment
| It should be noted that, in this example, the main source of forward looking information is expected future property prices. No account would appear to be taken of other economic data such as future levels of employment or interest rates. We assume that the Board took this approach to make the example simple, but it implies that future property prices are considered to provide a sufficient guide to future defaults that it is not necessary to take account of other data as well. |
IFRS 9 first specifies that, if an entity does not have reasonable and supportable information that is available without undue cost or effort to measure lifetime expected losses on an individual instrument basis, it must assess lifetime losses on a collective basis. This exercise must consider comprehensive information that incorporates not only past due data, but other relevant credit information, such as forward looking macro-economic information. The objective is to approximate the result of using comprehensive credit information that incorporates forward-looking information at an individual instrument level. (IFRS 9 B5.5.4) Individual or collective assessment for impairment
Next, the standard sets out how financial instruments may be grouped together in order to determine whether there has been a significant increase in credit risk. (IFRS 9 B5.5.5) Any instruments assessed collectively must possess shared credit risk characteristics. It is not permitted to aggregate exposures that have different risks and, in so doing, obscure significant increases in risk that may arise on a subset of the portfolio. Examples of shared credit risk characteristics given in the standard include, but are not limited to:
- Instrument type
- Credit risk ratings
- Collateral type Individual or collective assessment for impairment
- Date of initial recognition Individual or collective assessment for impairment
- Remaining term to maturity Individual or collective assessment for impairment
- Industry Individual or collective assessment for impairment
- Geographical location of the borrower
- The value of collateral relative to the asset (the loan-to-value or LTV ratio), if this would have an impact on the probability of a default occurring
The standard also states that the basis of aggregation of financial instruments to assess whether there have been changes in credit risk on a collective basis may have to change over time, as new information on groups of, or individual, financial instruments becomes available.(IFRS 9 B5.5.6)
See also: The IFRS Foundation
