Under IAS 39 credit losses were only recognised after the occurrence of a loss-event. In a worst case, this means that losses, which materialised immediately after loan origination, would only be reflected as of the subsequent balance sheet date. This timely discrepancy between the loss-event and its recognition has proven to be one of the drivers that fuelled the financial crisis that started in 2007. In retrospect, regulators around the globe concluded that the IAS 39 accounting was doing “[…] too little, too late […]”.1 Figure 1 attests to this conclusion by highlighting how the majority of impairments that originated from losses incurred during the financial crisis that started in 2007, were only realised thereafter. This observation holds true for banks in the U.S. as well as an international sample as obtained from Bankscope on the left and right side of the figure, respectively.

 

 

In response thereto, and following a call for change by the G20, the International Accounting Standards Board (IASB) has comprehensively revised the methodology for calculating loan loss provisions. Instead of recognising loan losses only after their occurrence, the new IFRS 9 accounting framework recognises expected credit losses (ECL) that have not yet materialised. Based on their credit quality, loans are assigned to one of three different stages of the impairment model, where a lower stage implies higher credit quality. Based on the respective stage, expected loan losses are calculated for either the next 12-months in the instance of good loans, or until their maturity in the case of underperforming and defaulted loans, respectively. Where loans are considered non-performing, the interest rate is furthermore only calculated on the net book value, as shown in Table 1.