This document provides guidance on credit risk management practices and the application of expected credit loss (ECL) accounting frameworks. It focuses on the assessment and measurement of expected credit losses and allowances, emphasizing the importance of sound credit risk management for the stability of banks. The recommendations aim to enhance the recognition and measurement of credit risks to ensure adequate…
Title: Guidance on credit risk and accounting for expected credit losses (IFRS 9 / CECL)
Author: Basel Committee on Banking Supervision
Year: 2015
Type: banking supervisory standard
Scope: credit risk management practices and accounting for expected credit losses (ECL) for loans, loan commitments, and financial guarantees, within applicable accounting standards (notably IFRS 9). The document covers guiding principles for banks and supervisors, focusing on the quality and consistency of practices for assessing and measuring expected losses. It does not address regulatory capital requirements on provisions for expected losses. The provided text covers about 24 pages out of 36.
This document establishes supervisory principles to guide banks in implementing and applying accounting frameworks based on expected credit losses (ECL), notably IFRS 9. The objective is to ensure robust, consistent, and transparent practices in assessing and measuring credit risk and related provisions, to avoid delays and deficiencies in loss recognition that contributed to the financial crisis. The Basel Committee emphasizes the responsibility of the board of directors and management in adopting sound methodologies, integrating experienced judgment and reasonable, supported forward-looking information, including macroeconomic factors. It recommends using common systems for risk management, expected loss measurement, and communication, as well as rigorous validation of models used. Supervisors must periodically evaluate the effectiveness of banks' practices, ensure estimation methods are appropriate, and consider these practices in assessing capital adequacy. The document stresses transparency through relevant and comparable public disclosures. Finally, an appendix details specific expectations for banks applying IFRS 9, notably on 12-month loss measurement and assessing significant increases in credit risk. This guidance aims to support high-quality implementation of ECL frameworks, contributing to financial stability and depositor protection (p. 1-24).
The document replaces the Basel Committee's 2006 guidance on loan loss assessment and provisioning, in a global transition context towards accounting frameworks based on expected credit losses (ECL). This evolution addresses a weakness identified during the financial crisis: excessively late and insufficient recognition of credit losses. The Committee aims to promote strong, integrated, and consistent credit risk management practices aligned with new accounting requirements, notably IFRS 9. The guide does not set regulatory capital rules but clarifies how accounting and risk management practices should be aligned and supervised. It is addressed to banks and supervisory authorities, emphasizing the need for rigorous, transparent implementation adapted to the size and complexity of institutions. It also highlights the importance of experienced judgment and incorporation of reasonable and supported forward-looking information (p. 5-8).
- Governance and responsibilities: The board of directors and management must ensure appropriate credit risk practices, effective internal control, and consistency of provisions with policies, accounting standards, and supervisory guidance (Principle 1, p. 4, 9-10).
- Robust methodologies for ECL: Banks must adopt, document, and apply solid methodologies covering policies, procedures, and controls to assess and measure credit risk on all loans. These methodologies must include clear definitions, consideration of forward-looking scenarios, granularity of loan groups by common risk characteristics, and model validation (Principles 2, 3, 5, p. 10-19).
- Experienced judgment and forward-looking information: The use of experienced judgment is essential to robustly incorporate reasonable and supported information, notably macroeconomic factors, in estimating expected losses. Banks must demonstrate the relevance and consistency of this information, apply varied scenarios, and avoid bias (Principle 6, p. 19-21).
- Common processes and data: Systems, tools, and data used for credit risk assessment and ECL measurement must be common and consistent with those used for risk management and determination of expected losses for regulatory capital purposes, to enhance reliability and transparency (Principle 7, p. 21-22).
- Disclosure and transparency: Banks must provide relevant, comparable, and decision-useful public information, including policies, definitions, ECL estimation methods, and significant changes from period to period. The integration of forward-looking information must be explained (Principle 8, p. 22-23).
- Supervision and assessment: Supervisors must periodically evaluate banks' credit risk and ECL practices, ensure estimation methods are appropriate, and that provisions accurately reflect risks. They must also incorporate these assessments in capital adequacy evaluations and take appropriate corrective actions (Principles 9, 10, 11, p. 23-26).
- IFRS 9 specifics: The appendix specifies that banks applying IFRS 9 must measure a provision at least equal to 12-month expected losses when credit risk has not increased significantly, and adopt an active approach to detect any risk changes (p. 26).
- Established facts: The shift to an expected credit loss (ECL) model improves early loss recognition compared to the prior incurred loss model. Banks must implement robust methodologies incorporating historical, current, and forward-looking information, regularly validated. Strong governance and internal control are essential to ensure estimate quality. Supervisors play a key role in evaluating and correcting banks' practices.
- Assumptions: Incorporating forward-looking information, notably macroeconomic, relies on experienced judgment and reasonable, supported scenarios. ECL models must be validated and adjusted to reflect changes in economic conditions and risk profiles.
- Interpretations: The Committee emphasizes that using common models for accounting and risk management promotes consistency and transparency. It acknowledges that ECL estimation involves subjectivity but stresses the need to avoid bias and delays in loss recognition.
- Uncertainties: ECL measurement is sensitive to data quality, relevance of forward-looking scenarios, and applied judgment. Differences between accounting frameworks and jurisdictions may cause estimation divergences. The use of temporary measures (adjustments) should remain exceptional and documented.
The Basel Committee recommends that banks adopt a disciplined and integrated approach to assessing and measuring expected credit losses, based on robust methodologies, experienced judgment, and reasonable and supported forward-looking information. It stresses the responsibility of the board of directors and management in governing these practices, as well as the need for effective internal control and rigorous model validation. Banks must ensure transparency through relevant and comparable public disclosures. Supervisors must regularly evaluate banks' practices, ensure provisions are adequate, and take corrective measures in case of deficiencies, including in assessing capital adequacy. For banks applying IFRS 9, particular attention should be given to measuring 12-month expected losses and promptly detecting significant increases in credit risk. These recommendations aim to ensure high-quality implementation of ECL frameworks, contributing to financial stability and depositor protection.
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