How to estimate expected credit losses – ECL – for provisioning under IFRS 9

What is it about?

There is no clear guidance from the accounting standard setters at the IASB (or the FASB) on the measurement of ECL. This paper presents an approach to estimate ECL provisioning under IFRS 9 that reduces the management subjectivity inherent in the estimation process. The proposed approach, targeting the low-default portfolios, is practical, easy-to-implement and theoretically sound. It considers long-run default rates and long-run average credit spreads to extract the default component from the currently observed spreads and recalibrates the spread-implied point-in-time default probabilities. This approach does not require arbitrary assumptions regarding future economic conditions commonly employed in scenario analyses.

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