Last update 18/08/2019
One major tool to finance corporations is via credit line commitments. These are short term credit lines that firms can withdraw from their banks, up to a certain, predetermined ceiling, at a certain cost, usually above the interest rate on long term credit. The credit lines serve corporations to finance, usually, short term financial needs, when cash outflows are greater than cash inflows. Also, credit lines are used as a buffer against unexpected short term gaps as well as to take advantage of unexpected investment opportunities. Thus, loan commitments can be employed defensively as well as offensively by the corporations.
Most companies keep cash, or liquid reserves to serve their immediate needs and provide a buffer for future potential uses. The two common forms to safeguard liquidity is first, by keeping enough liquid reserves, or, second, by signing a credit line, or loan commitment agreement.
The following loan commitments are within the scope of IFRS 9: [IFRS 9 2.3]
- loan commitments that the entity designates as financial liabilities at fair value through profit or loss (see Fair value option for financial liabilities). An entity that has a past practice of selling the assets resulting from its loan commitments shortly after origination shall apply IFRS 9 to all its loan commitments in the same class.
- loan commitments that can be settled net in cash or by delivering or issuing another financial instrument. These loan commitments are derivatives. A loan commitment is not regarded as settled net merely because the loan is paid out in installments (for example, a mortgage construction loan that is paid out in installments in line with the progress of construction).
- commitments to provide a loan at a below-market interest rate. [IFRS 9 4.2.1 (d)] An issuer of such a commitment shall (unless the recognised liability will be measured at fair value [IFRS 9 4.2.1 (a)]) subsequently measure it at the higher of:
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- the amount of the loss allowance determined in accordance with IFRS 9 5.5 Impairment (the expected credit losses model), and
- the amount initially recognised [IFRS 5.1.1] less, when appropriate, the cumulative amount of income recognised in accordance with the principles of IFRS 15.
Expected credit losses – Loan commitments and financial guarantees [IFRS 9 Appendix A: Loss allowance]
- The three-stage expected credit loss model also applies to these off-balance sheet financial commitments
- An entity considers the expected portion of a loan commitment that will be drawn down within the next 12 months when estimating 12 month expected credit losses (stage 1), and the expected portion of the loan commitment that will be drawn down over the remaining life the loan commitment (stage 2)
- For loan commitments that are managed on a collective basis, an entity estimates expected credit losses over the period until the entity has the practical ability to withdraw the loan commitment.
Loan commitments
Loan commitments
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