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5 views6 pages

Banking

Uploaded by

Rara Mignonne
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Slide 1

Hello everyone, I’m Azra and I will


be discussing Significant Increase
in Credit Risk. So, let’s look at the
definition. IFRS 9 does not provide
a strict definition of what
constitutes a significant increase in
credit risk. Instead, it emphasizes
the use of reasonable and
supportable information that is
readily available without undue
cost or effort. This assessment
should incorporate both forward-
looking information and historical
data, such as the past due status
of payments.

Slide 2
We can assess credit risk
qualitatively or quantitatively. On
the qualitative side, internal data
such as changes in loan terms or
forbearance offered must be
considered, alongside external
data like borrower-specific credit
spreads and market-wide external
data such as economic conditions.
For the quantitative aspect, we
may track changes in Probability of
Default (PD) over time. For
instance, if initial risk of default is
3% and it increases to 4%, the 1%
change is considered more
significant if compared to the
second situation, where initial PD
is 15% and it increases to 16%.

Slide 3
There are several indicators that
can signal an increase in credit
risk:
Significant changes in internal
price indicators, significant
changes in the instrument’s
external credit ratings, adverse
changes in business, financial, or
economic conditions, significant
changes in the operating results of
the borrower, and past due
information of the borrower.
IFRS 9 also introduces a rebuttable
presumption on past due
payments. If contractual payments
are more than 30 days overdue,
we can automatically assume that
there has been a significant
increase in credit risk. However,
we should assess overall credit
quality before relying solely on this
presumption. So this should be the
last thing that we assess after the
other indicators. There are many
more relevant indicators of credit
risk that you may refer in the
textbook.

Slide 4
Now, let's discuss collective
assessments. This approach is used
if it is too costly to measure the
lifetime expected credit losses of
financial assets individually, so we
measure them in groups.
This approach is particularly
relevant for financial institutions
managing large portfolios with
many small exposures, like retail
loans. When assessing credit risk
collectively, banks should consider
shared characteristics such as
instrument type and credit ratings
to evaluate whether there has
been a significant increase in risk
since initial recognition.

Slide 5
Another important point is
collateral considerations. Banks
must assess significant increases in
credit risk without factoring in
collateral value, however the value
of collateral does play a role when
measuring expected losses. What
this means is that even if there’s a
significant increase in credit risk,
the impact on expected loss
allowance may be lower for
collateralised or secured loans
compared to unsecured loans.
Also, risk of default occuring over
the expected life of an instrument
usually decreases the closer we
get to the maturity date. Because
the closer we are to the maturity,
more payments will have already
been made, thereby reducing the
amount that may be defaulted.
However, some instruments only
have significant payment
obligations close to maturity. In
those cases, the risk of default
may not necessarily decrease as
time passes.

Slide 6
We must also consider
sustainability and ESG factors.
Changes in these areas can lead to
increased credit risk due to
physical risks from climate change
or transition risks which is caused
by shifts in market demand or
regulations. For example, extreme
weather events like floods can
directly impact a business's supply
chain, which disrupts cash flows
and increase default probabilities.

Slide 7
Let’s look at an example. You may
pause and read the scenario, and
the requirement is What approach
should Canary Bank take to assess
whether there has been a
significant increase in credit risk in
respect of the loan to Gunn plc?
Slide 8
So, Canary Bank should use
reasonable and supportable
information available without
undue cost or effort to assess the
credit risk of the loan to Gunn plc.
The forecast financial information
must be analysed along with any
other forward looking information
available for the industry or
economy. The fact that Gunn plc
has not defaulted over the prior
three years should be taken into
account but is not indicative of
future performance.
Canary Bank should assess
whether prior year financial
statements would have breached
the interest cover covenant if IFRS
16 had been applied early; the
probability of default now
compared with when the loan was
originated; any forbearance
offered to Gunn plc; external
credit ratings for Gunn’s debt, if
available; and industry growth and
performance data.

Slide 9
Now let’s look at an interactive
question. Shinrin Bank has a
mortgage portfolio with a total
gross value of £550 million. The
individual loans generally have an
outstanding balance under
£200,000.
We are required to explain how
Shinrin Bank may segment the
mortgage portfolio to assess
whether there has been any
significant credit deterioration
within the mortgage portfolio.

Slide 10
So, as I have discussed before, the
collective assessment approach is
particularly relevant for financial
institutions managing large
portfolios with many small
exposures. Shinrin has a $550
million portfolio but each loan has
under $200,000 balance. Thus, It is
reasonable for Shinrin Bank to
assess the mortgages collectively,
because it is not feasible to assess
individually each loan of under
£200,000 in a portfolio of £550
million. The costs of individual
assessment would outweigh the
benefits. Shinrin Bank should
segment the portfolio based on
shared credit risk characteristics.
For example, the loans could be
categorised by interest rate type
(fixed/variable), loan to value,
remaining time to maturity, type
of mortgage and the borrower’s
credit rating. Once the loans are
categorised into groups based on
shared credit risk characteristics,
Shinrin Bank must assess whether
there has been a significant
increase in credit risk since initial
recognition. They should use
historical information such as any
past default and forbearance
offered as well as relevant forward
looking information such as
unemployment rates and interest
rates. If there has been a
significant increase in credit risk
since origination, the impairment
loss allowance is increased from
12-month expected credit losses
to lifetime expected credit losses.
Also, it may be necessary to make
changes to the segmentation of
the loans as updated information
on expected credit losses becomes
available. For example, there may
be a significant increase in credit
risk on only one portion of variable
rate loans which would require
impairment loss allowance based
on lifetime expected credit losses,
while the remaining variable rate
loans continue to recognise
impairment as normal, based on
12-month expected credit losses.

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