Understanding Expected Credit Losses (ECL) under IFRS 9

Topics to be Covered:

1. Introduction to IFRS 9: Overview of the IFRS 9 financial instruments standard and its significance.
2. Understanding ECL: Detailed explanation of the Expected Credit Losses (ECL) model and its components.
3. ECL Calculation: Step-by-step guide on how to calculate ECL, including key assumptions and methodologies.
4. Impact on Financial Statements: How ECL affects financial reporting and the overall financial health of a business.
5. Best Practices: Tips and best practices for implementing the ECL model effectively.
6. Q&A Session: An opportunity to ask questions and get expert advice from Saiheal Narayan.

About the Speaker:

Saiheal Narayan is the Head Data Scientist at Trade Shield, specializing in credit risk analytics and predictive modeling. With extensive experience in the field, Saiheal brings a wealth of knowledge and practical insights into the application of the ECL model under IFRS 9.

Expected Credit Losses (ECL) are a way for banks and other financial institutions to estimate how much money they might lose if people or businesses don't pay back their loans. Here's a simple analogy:

Imagine you lend your friend R100. You hope they'll pay you back, but there's a chance they might not. To be prepared, you might set aside some money just in case they don't repay you. This is similar to what banks do with ECL.

Here's how it works:

Probability of Default (PD): This is the chance that the borrower (your friend) won't pay back the loan. For example, if there's a 10% chance your friend won't repay, the PD is 10%.

Exposure at Default (EAD): This is the amount of money the bank stands to lose if the borrower defaults. In your case, it's the R100 you lent.

Loss Given Default (LGD): This is the percentage of the loan that the bank expects to lose if the borrower defaults. If you think you'll lose 50% of the R100, the LGD is 50%.

To calculate the ECL, you multiply these three factors together:

ECL=PD×EAD×LGD 

Using our example:

ECL=10%×R100×50%=R5 

So, you'd set aside R5 to cover the potential loss.

In summary, Expected Credit Losses help banks prepare for the possibility that some loans won't be repaid, ensuring they have enough money set aside to cover those losses. It's a way to manage risk and stay financially healthy.

Glossery:

1. Impairment/Provision: Money set aside to cover the expected losses on a credit product by a financial institution.

2. Credit Products: Financial products that involve lending money, such as loans (mortgages, vehicle financing, corporate banking, personal loans), credit cards, overdrafts, and clothing accounts.

3. Non-Credit Products: Products that do not involve lending money but may still require provisions, such as trade receivables.

4. ECL (Expected Credit Loss): The expected loss on a credit product, calculated using the formula:

   $$\text{ECL}=\text{PD}\times \text{EAD}\times \text{LGD}$$

   Where:

   • PD (Probability of Default): The likelihood that a borrower will default on their obligation.
   • EAD (Exposure at Default): The total value that a financial institution is exposed to when a borrower defaults.
   • LGD (Loss Given Default): The amount of loss a financial institution incurs when a borrower defaults, expressed as a percentage of the EAD.

5. Provisioning: The process of setting aside money to cover expected credit losses.

6. Trade Receivables: Amounts owed to a business by its customers for goods or services provided on credit.

Watch the video below: