Credit-impaired assets and stage 3

When is a financial asset credit-impaired?

IFRS 9 lists events that are evidence of credit impairment:

• significant financial difficulty of the issuer or borrower;
• a breach of contract, such as a default or a payment more than 90 days past due;
• a concession granted to the borrower, for economic or contractual reasons relating to its financial difficulty, that the lender would not otherwise consider;
• it becoming probable that the borrower will enter bankruptcy or another financial reorganisation;
• the disappearance of an active market for the asset because of financial difficulties;
• the purchase or origination of an asset at a deep discount that reflects credit losses already incurred.

It may not be possible to identify a single event; the combined effect of several may cause the asset to become credit-impaired. The definition of default a lender uses must be consistent with its credit risk management, with a rebuttable presumption that default occurs no later than 90 days past due, and most lenders treat defaulted assets as credit-impaired.

How does stage 3 differ from stage 2?

How is interest revenue on a credit-impaired asset calculated?

A loan with a gross carrying amount of 100,000 and an effective interest rate of 10% becomes credit-impaired; its lifetime ECL is 40,000.

In stage 3, interest revenue reflects only the cash the lender expects to collect. The change applies from the next reporting period after the asset becomes credit-impaired, and reverses if the asset later cures.

What are POCI assets?

Purchased or originated credit-impaired assets, such as distressed debt bought at a deep discount, are credit-impaired from initial recognition. No 12-month allowance is recognised on day one: expected losses are built into a credit-adjusted effective interest rate. Afterwards, only changes in lifetime ECL since initial recognition are recognised, as impairment gains or losses, and a POCI asset never moves to stage 1 or 2, even if it recovers.

Is the accounting definition of default the same as the regulatory one?

IFRS 9 does not require it, but most banks align the two, because their PD models are built on the regulatory definition and supervisors expect consistency. Companies outside banking set their own definition, usually based on days past due and known financial difficulty, and apply it consistently across their receivables and loans.

When is a credit-impaired asset written off?

When the lender has no reasonable expectation of recovering the asset, in whole or in part. A write-off reduces the gross carrying amount and the allowance together (see ECL journal entries), so it does not affect profit if the asset was fully provided for. Enforcement activity can continue after a write-off, and later recoveries are recognised in profit or loss.

Can a credit-impaired asset recover?

Yes. If the borrower clears its arrears and the credit-impairment events no longer apply, the asset moves back to stage 2, or stage 1 if its credit risk is no longer significantly higher than at origination, usually after a probation period. Interest revenue then returns to the gross basis. See the 30 and 90 day presumptions, ECL stages explained and the effective interest method.

This guide is general information. It is not tax or legal advice for your situation.