A significant increase in credit risk is the IFRS 9 test that moves an asset from Stage 1 to Stage 2. Banks usually combine a relative change in lifetime probability of default, watchlist or forbearance flags, and the rebuttable 30 days past due backstop.
IFRS 9 stagingIFRS 9 staging sorts financial assets into three buckets by credit quality since initial recognition. Stage 1 carries a 12-month expected credit loss, Stage 2 (significant increase in credit risk) and Stage 3 (credit-impaired) carry a lifetime expected credit loss.
Expected credit loss (ECL)Expected credit loss is the probability-weighted estimate of credit losses over a period, the basis of IFRS 9 loss allowances. It is usually computed as PD x LGD x EAD, discounted at the effective interest rate, over 12 months for Stage 1 and over the lifetime for Stages 2 and 3.
Probability of default (PD)Probability of default is the likelihood that a borrower defaults over a given horizon, usually one year. Capital models use a long-run average (through-the-cycle) PD per rating grade, while IFRS 9 uses point-in-time 12-month and lifetime PDs that react to the economic outlook.
Early warning indicators (credit)Early warning indicators are signals that a borrower's credit quality is weakening before default, such as overdraft excesses, missed covenants, rating downgrades, falling turnover or negative news. Triggered cases go to a watchlist for closer review and action.
Probability of default (PD)Probability of default is the likelihood that a borrower defaults over a given horizon, usually one year. Capital models use a long-run average (through-the-cycle) PD per rating grade, while IFRS 9 uses point-in-time 12-month and lifetime PDs that react to the economic outlook.
ForbearanceForbearance is a concession, such as a payment holiday, longer maturity or lower rate, granted to a borrower facing or about to face financial difficulty. The CRR defines forborne exposures, which carry probation periods before the flag can be removed.