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Financial instruments — Impairment (IASB-FASB)

Date recorded:

Responsiveness of the impairment model

The IASB discussed concerns raised that the proposed impairment model may not capture significant increases in credit risk on a timely basis when such increases are not evident at the individual exposure level. This is particularly the case for retail loans when credit risk is not reassessed on an on-going basis at an individual exposure level before loans become delinquent.

The concern arises because of the information that would be used to apply the proposed model. In particular, when credit risk systems are heavily dependent on delinquency information, a significant increase in credit risk may not be evident at the individual financial instrument level before financial instruments become delinquent. In other words, there will be a delay between recognising significant increases in credit risk and actual credit events.

Some constituents understood that the proposed model would mean that they could assess a significant increase in credit risk by applying only the “30 days past due” rebuttable presumption for retail products even where forward looking factors are available (provided that the forward looking information cannot be applied at an individual exposure level). The problem with this approach is that it would result in understating the extent to which a significant increase in credit risk has occurred.

The IASB acknowledged that the timeliness of capturing significant increases in credit risk primarily depends on whether the entity has the information available and can identify increases in a timely manner before loans become delinquent. Consequently, identifying and capturing significant increases in credit risk will vary by entity and by product. At one end of the spectrum, entities will be able to capture all significant increases in credit risk on a timely basis for individual financial instruments (this includes changes in credit risk due to current and future expected macroeconomic conditions. At the other end of the spectrum are entities or portfolios for which entities do not have information to identify the signals of a significant increase in credit risk or where they cannot link these signals to an individual borrower level before a loan becomes delinquent.

Initially, there seemed to be a lot of confusion around the discussion of what timeliness of identification of increases in credit risk meant for portfolios of assets. One Board member noted that the problem, as he sees it, was that some were questioning whether entire portfolios would move from Stage 1 to Stage 2 when credit risk increased significantly. This Board member summarised his understanding by saying that as long as the portfolio is a homogeneous group of assets and credit risk deteriorated significantly it would force the entire portfolio from Stage 1 to Stage 2. If the increase in credit risk results in portfolios being able to be re-segmented, it is possible to leave one part of the portfolio in Stage 1, but the part of the portfolio for which there is a significant increase in credit risk would have to move from Stage 1 to Stage 2. However, they noted that it still requires that entities look at forward looking information and that they cannot just look at delinquency (for examples 30 days past due) as indicators for increases in credit risk. In portfolio scenarios it is easier to identify the implications of changes in macroeconomic conditions on expected credit losses. The staff reiterated that they thought it was important that guidance be provided for entities to understand that forward looking information must be taken into consideration whether it will be on an individual asset level or portfolio level.

The IASB discussed some alternative approaches to address this issue. However, the IASB did not want to prescribe specific methods and techniques for entities to comply with in order to identify increases in credit risk on a timely basis.

The staff recommended an approach that would clarify the proposals on significant increases in credit risk in the exposure draft and include illustrative examples to reflect the intention of the proposals. These examples would cover the types of increases in credit risk to be considered and note that portfolio analysis might be required.

Fourteen IASB members agreed with these decisions. Two IASB members were not present.  

Measurement objective

The IASB discussed whether it wanted to retain the 12-month expected credit loss measurement objective for financial assets in Stage 1 of the proposed model. The Board was not asked to consider any alternatives to this model at this stage, just whether it wanted to retain the proposed model.

The staff explained some of the concerns raised on the 12-month expected credit loss measurement objectives. Some of the concerns raised are summarised below:

  • Some (specifically regulators) were concerned that the 12-month expected credit loss would not adequately reflect the expected credit losses inherent in some financial instruments. They believe that an outlook period of more than 12 months could be a solution. Others specifically commented that they were strongly opposed to extending the loss allowance for financial instruments that have not significantly deteriorated beyond 12 months.
  • Some entities with less sophisticated credit risk management systems requested additional guidance and examples on how to implement the proposals. Some commented that for Basel-regulated entities, the operational complexity could be further reduced if the 12-month expected credit losses were fully aligned to the expected credit losses applied for prudential regulatory purposes.

The staff paper summarised some of the suggestions that respondents made in terms of the 12-month expected credit loss measurement objective.

The staff asked the IASB whether they wanted to retain this measurement objective or not in light of the comments received.

One IASB member expressed disagreement with the 12-month expected loss measurement objective. He stated that he is still not convinced with the arguments for the measurement objective and said that his alternative view in the exposure draft is still valid for him. Even though the respondents agreed that the 12-month expected credit loss measurement objective as a practicable alternative to full life time losses, he did not believe it served as a good proxy or estimation of what was proposed in the conceptually superior exposure draft in 2009. He also questioned whether short-term lenders were not being penalised under the proposals. This is because their borrowing period is normally shorter than 12 months and hence, there is no real distinction between Stage 1 and Stage 2 for such entities.

Other Board members indicated that they believed that respondents understood the limitations of the proposals and that it is a very crude estimation of what was proposed in the 2009 exposure draft, and that no new information has come to light to make them change course at this stage. Hence, the same arguments that led them to the conclusion they reached in the exposure draft was still applicable.

In light of the comments received, twelve IASB members agreed with these decisions. Two IASB members were not present.

Definition of default

The exposure draft did not propose a definition of default or provide any application guidance on what constitutes a default event or how it should be interpreted. This is because the IASB did not expect that expected credit losses would change as a result of differences in the definition of default because of the counterbalancing interaction between the way an entity defines default and the credit losses that arise given that definition.

The staff provided feedback that many respondents felt that the IASB presumption that the definition of default would not make a difference was not correct. They emphasised that default should be clearly defined because the notion of default is fundamental to the application of the proposed model. Others were concerned that the absence of a definition of default would result in inconsistent application and result in a lack of comparability. Regulators in particular were concerned that default may be interpreted as non-payment instead of capturing indicators of loss expectations that accelerate eventual non-payment.

The IASB then discussed a number of alternative approaches that ranged from doing nothing to prescribing what default meant (e.g. anything that is 90 days past due).

One Board member felt that default should be described in a qualitative capacity as an event that changes the management objective. He felt that this would make the application of the proposals more consistent amongst entities. Others felt that defining default in any way would restrict entities to reflect the true risk management practices.

The Board members showed a lot more support for a view where default was aligned to credit risk management and to allow entities to define default in line with their credit risk management practices. However, the Board understood that less sophisticated entities might not have such detailed prescribed internal definitions outside of the financial services industry. Consequently, they agreed to an approach where a rebuttable presumption would be included in the final standard that default would be anything that is 90 days past due.

Thirteen IASB members agreed with these decisions. One IASB member was not present.

Report on fieldwork

The staff reported on the fieldwork performed during the comment period as a follow up to the discussions held during the July 2013 joint IASB and FASB meeting.

In summary the staff explained that participants to the fieldwork indicated that the proposed model was operable. The participants did indicate that the proposals are difficult to apply in some instances and require significant effort and time.

Details of the feedback on the fieldwork can be found in agenda paper 5D of the September 2013 meeting.  

General observations on convergence

At this meeting, the US standard setter, the FASB, discussed and made some tentative decisions regarding their impairment model. After the FASB finished their deliberations, an IASB member asked the FASB how they were going to work together to get to a converged solution seeing that both boards have just made decisions independently that seemingly took them further apart from each other. Both boards indicated that it would probably be best for each to discuss their models and for both boards to follow the other’s conversations and hopefully in the end try and resolve any differences that resulted from their discussions.

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