Guidance on accounting for expected credit losses

Feb 16, 2015

expected credit loss

For a whitepaper on this topic, access Transitioning to an Expected Loss Model


In February 2015, the Basel Committee on Banking Supervision released a consultative document highlighting the expectations associated with the transition to accounting for expected credit losses. The objective of the document is to “set out supervisory requirements on sound credit risk practices associated with the implementation and ongoing applications of expected credit loss (ECL) accounting models.”

Because the Basel Committee operates independently of the FASB, IASB and other accounting standard setters, this document serves as a type of universal overview of what is needed to transition from an incurred loss model to one of expected loss. As the committee put it, “the paper is intended to set forth supervisory requirements for ECL accounting that do not contradict the applicable accounting standards established by the IASB or other standard setters…the requirements described are equally applicable under all accounting frameworks.”

So what does that mean then for banks in the United States anticipating the FASB’s release of its “IFRS 9 relative,” the Current Expected Credit Loss (CECL) model? Well, while we still don’t know exactly what an expected loss calculation will entail, we have better insight into what will be required to make the transition to the new model.

The Committee highlights eleven principles for sound credit risk practices that interact with expected credit loss measurement:

Principle 1: A bank’s board of directors (or equivalent) and senior management are responsible for ensuring that the bank has appropriate credit risk practices, including effective internal controls, commensurate with the size, nature and complexity of its lending exposures to consistently determine allowances in accordance with the bank’s stated policies and procedures, the applicable accounting framework and relevant supervisory guidance.

Principle 2: A bank should adopt, document and adhere to sound methodologies that address policies, procedures and controls for assessing and measuring the level of credit risk on all lending exposures. The robust and timely measurement of allowances should build upon those methodologies.

Principle 3: A bank should have a process in place to appropriately group lending exposures on the basis of shared credit risk characteristics.

Principle 4: A bank’s aggregate amount of allowances, regardless of whether allowance components are determined on a collective or an individual basis, should be adequate as defined by the Basel Core Principles, which is an amount understood to be consistent with the objectives of the relevant accounting requirements.

Principle 5: A bank should have policies and procedures in place to appropriately validate its internal credit risk assessment models.

Principle 6: A bank’s use of experienced credit judgment, especially in the robust consideration of forward-looking information that is reasonably available and macroeconomic factors, is essential to the assessment and measurement of expected credit losses.

Principle 7: A bank should have a sound credit risk assessment and measurement process that provides it with a strong basis for common systems, tools and data to assess and price credit risk, and account for expected credit losses.

Principle 8: A bank’s public reporting should promote transparency and comparability by providing timely, relevant and decision-useful information.

Principle 9: Banking supervisors should periodically evaluate the effectiveness of a bank’s credit risk practices.

Principle 10: Banking supervisors should be satisfied that the methods employed by a bank to determine allowances produce a robust measurement of expected credit losses under the applicable accounting framework.

Principle 11: Banking supervisors should consider a bank’s credit risk practices when assessing a bank’s capital adequacy

These principles serve as overarching guidelines under which banks should operate, but lack specificity and context as written. Not to fear, the document dissects these eleven principles in detail, spanning just under forty pages. For convenience’s sake, here are a few high-level takeaways that may differ from what is currently required under an incurred loss model: