As per RBI guidelines on Ind-AS 109, it is worthwhile to move towards a robust Expected Credit Loss (ECL) provisioning methodology from the existing Incurred Loss Provisioning method. Through this paper, the author explains the ECL implementation process at three hypothetical banks. These banks are diverse in nature with reference to their risk appetite, turnover, portfolios, vintage, and business prospects.

The global financial crisis (GFC) in 2008 exemplified the weaknesses in the current accounting standards & practice (IAS 39 Financial Instruments), which adopts the incurred loss model for impairment of financial assets. The challenge with the incurred loss model is that impairment losses and the resulting write-downs in the reported value of financial assets can only be recognized when there is evidence that they exist (i.e. have been incurred). Post GFC 2008, at the request of the G20 and the Financial Stability Board, the International Accounting Standard Board (IASB) stepped up its work to replace IAS 39. In July 2014, the IASB introduced the International Financial Reporting Standard (IFRS) 9.

The Indian Accounting Standard (Ind-AS) is converged with the IFRS. It is the accounting standard adopted by companies in India and issued under the supervision of the Accounting Standard Board (ASB). Accordingly, Ind-AS 109 is converged with IFRS9.

Ind-AS 109 lays out the guidelines for accounting based on the expected credit loss model. The objective of this standard is to establish reporting principles that will present relevant and useful information to users of financial statements for the assessment of the amount, timings and uncertainty of the entity’s future cash flows. This standard will have an impact on the measuring and accounting of credit losses, which means that the risk and finance team of an organization needs to collaborate with the IT department for implementation and complying with Ind-AS 109 standards.

Overview: Key components of the Ind-AS 109 requirements for banks

To ascertain the applicability of the impairment calculation, an entity needs to classify its financial instruments into amortized cost, fair value through other comprehensive income (FVOCI) and fair value through P&L (FVTPL). Instruments classified as amortized cost and FVOCI are subject to the Ind-AS 109 impairment calculation. The standard requires banks to assess credit risk on the financial instruments to ascertain if there is an increase in risk on the reporting date as compared to the date of initial recognition. The standard also requires banks to assess their portfolio and determine the criteria for stage determination depending on the portfolio risk characteristics. There are certain rebuttable presumptions provided by the standard such as - 30 days past due (DPD) for classifying an asset into Stage-2 and default should not occur later than when a financial asset is 90 days past due. Per Ind-AS 109 standards, an entity can refute this presumption if it has reasonable information that is available without undue cost or effort, and demonstrates that risk has not increased significantly since initial recognition.

The 12-month or lifetime Expected Credit Loss (ECL) is computed and accounted for based on whether the financial instrument is classified as Stage 1 or 2/3. The components that are crucial to calculate ECL include - Exposure at Default (EAD), Probability of Default (PD), Loss Given Default (LGD), and discount rate. These models are expected to be validated at least once in a year or at a more frequent interval; if required.

Case Study: ECL deployment for 3 banks

Based on experience and industry inputs, we have presented practical aspects of the Ind-AS 109 (ECL) implementation through case studies of three hypothetical banks to elucidate the best feasible approach. These banks are quite diverse in nature with reference to their risk appetite, turnover, portfolios, vintage, and business prospects.

Conclusion and Future Ahead

These 3 ECL computation exercises have identified some pointers to carry out a swift deployment process. 

• ECL computation is a data-intensive exercise. A bank must possess sufficient historical data that covers at least one economic cycle. In the absence of such data, banks usually opt for alternative approaches such as relying on the external data or Basel prescribed LGD and CCF for the initial adoption. However, system enhancement can be accomplished by performing a thorough analysis of existing data and systems, identifying gaps thereof and plugging those gaps before assessment of the portfolio. 
• Credit risk assessment at a borrower level is critical. It has been observed that banks are facing challenges in terms of having a single customer level identifier on account of data quality issues and processes. A unique identifier needs to be assigned for identifying unique exposure through matching criteria and segmentation based on the unique risk characteristics.
• Banks face several challenges in justifying the ECL numbers; especially in case if the chosen modeling techniques are inappropriate. Also, they face challenges in term of explaining the period on period moves in the ECL numbers due to the inconsistency in the model outputs. Banks need to perform a thorough analysis of the portfolio in order to gain an in-depth understanding of the portfolio risk characteristics to enable apt modeling techniques.  
• Review of the models needs dissemination of critical information in a timely manner and without any loss of information. It can only be achieved if there is a robust model validation process in place. It would ensure the effectiveness and efficacy of the models in estimating the risk parameters.
• Since Ind-AS 109 / ECL is a newly introduced standard; it is hard to find well-qualified resources. Hence banks need to have concrete training plans and take the assistance of external consulting firms, when required. 
• Banks need to ensure that the selected solution meets the technical consideration and business requirements. The finalization of the ECL computation software needs to be done well in time to avoid challenges and additional efforts in terms of technical compatibility and business requirements. We hope that banks would consider all these prescribed measures and take their Ind-AS journey ahead.

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Chiranjibi Panda 

Sr. member – DMTS and Practice Head, Risk & Compliance, Wipro Limited

chiranjibi.panda@wipro.com