Expected credit losses under IFRS 9: the three stages

Expected credit loss is the part of IFRS 9 that changed bank balance sheets most, and it applies to every company's loans and receivables. This guide explains the ECL stages, the difference between 12-month ECL and lifetime ECL, what a significant increase in credit risk means, and works through an ECL calculation example.

By Muhammad Bilal, Chartered Accountant. Reviewed by Awais Jameel, Chartered Accountant. Checked against official sources on . 3 minute read.

Short answer

An expected credit loss (ECL) is the probability-weighted estimate of credit losses over a financial asset's life. IFRS 9 uses three stages: stage 1 assets carry a loss allowance equal to 12-month ECL; stage 2 assets, whose credit risk has increased significantly since initial recognition, carry lifetime ECL; and stage 3 assets, which are credit-impaired, carry lifetime ECL with interest revenue calculated on the net carrying amount. ECL is usually calculated as PD x LGD x EAD, weighted across economic scenarios.

At a glance

Stage 1
12-month ECL
Stage 2
Lifetime ECL after significant increase
Stage 3
Lifetime ECL, credit-impaired
Formula
PD x LGD x EAD
Scenarios
Probability-weighted
Excel
ECL provision matrix
Expected credit losses under IFRS 9: the three stagesStage 1: 12-month ECL; Stage 2: Lifetime ECL after significant increase; Stage 3: Lifetime ECL, credit-impaired; Formula: PD x LGD x EAD; Scenarios: Probability-weighted; Excel: ECL provision matrix.KEY FACTS AT A GLANCEExpected credit losses under IFRS 9: the threestagesStage 112-month ECLStage 2Lifetime ECL aftersignificant increaseStage 3Lifetime ECL,credit-impairedFormulaPD x LGD x EADScenariosProbability-weightedExcelECL provision matrixChecked against official sourcesTax BakersExpected credit losses under IFRS 9: the three stagesStage 1: 12-month ECL; Stage 2: Lifetime ECL after significant increase; Stage 3: Lifetime ECL, credit-impaired; Formula: PD x LGD x EAD; Scenarios: Probability-weighted; Excel: ECL provision matrix.KEY FACTS AT A GLANCEExpected credit losses under IFRS9: the three stagesStage 112-month ECLStage 2Lifetime ECL after significant increaseStage 3Lifetime ECL, credit-impairedFormulaPD x LGD x EADScenariosProbability-weightedExcelECL provision matrixChecked against official sourcesTax Bakers
Key facts at a glance, as set out in this guide.

What are the three ECL stages?

The three stages of expected credit lossesThe three stages of expected credit lossesStage 1Stage 2Stage 3Credit riskNot significantlyincreasedSignificantlyincreasedCredit-impairedLoss allowance12-month ECLLifetime ECLLifetime ECLInterest revenue onGross carryingamountGross carryingamountNet carryingamount
Assets move between stages as credit risk changes; the allowance follows.

12-month ECL is the part of lifetime losses that results from default events possible within 12 months of the reporting date. Lifetime ECL covers default events possible over the whole expected life. Moving an asset from stage 1 to stage 2 can therefore increase its allowance many times over, even though the asset has not defaulted.

What is a significant increase in credit risk?

The test compares the risk of default over the expected life at the reporting date with the risk at initial recognition. Indicators include a downgrade in internal or external credit rating, a large rise in the probability of default, adverse changes in the borrower's business, breaches of covenants and payments becoming overdue. IFRS 9 contains a rebuttable presumption that credit risk has increased significantly when payments are more than 30 days past due, and that default has occurred when they are more than 90 days past due. An asset with low credit risk at the reporting date, such as an investment-grade bond, may be assumed not to have had a significant increase.

How is expected credit loss calculated? PD, LGD and EAD

  • Probability of default (PD): the likelihood the borrower defaults, over 12 months or over the life.
  • Loss given default (LGD): the share of the exposure lost if default occurs, after collateral and recoveries.
  • Exposure at default (EAD): the amount owed at the time of default, including expected drawdowns of facilities.

Expected credit loss = PD x LGD x EAD, discounted at the effective interest rate. Real models use a term structure of PDs for each future year rather than one number.

An ECL calculation example

PortfolioStageEAD (CU)PD usedLGDECL (CU)
Performing corporate loans110,000,0001%40%40,000
Loans on a watch list22,000,00015%40%120,000
Defaulted loans3500,000100%60%300,000
Total460,000

Stage 1 uses the 12-month PD of 1%; stage 2 uses the lifetime PD of 15%; stage 3 loans have defaulted, so the loss is the LGD of 60% on the exposure.

How are economic scenarios weighted?

ECL must be unbiased and probability-weighted, reflecting a range of possible outcomes, not just the most likely one. Suppose the bank uses a base case weighted 60%, a downside weighted 30% in which PDs are 1.5 times higher, and an upside weighted 10% in which they are 0.8 times. The weighted PD multiplier is 1.13, so stage 1 and 2 losses rise to CU 45,200 and CU 135,600, and the total allowance to CU 480,800. The three stages sheet in the ECL provision matrix (Excel) performs this calculation.

Is there a simpler approach?

Yes. For trade receivables and contract assets without a significant financing component, IFRS 9 requires the simplified approach: lifetime ECL from day one, with no need to track stages. Most companies apply it with a provision matrix.

What are management overlays?

Adjustments outside the models for risks the models do not capture, such as a new economic shock or a sector-specific problem. Regulators expect overlays to be justified, measured and reviewed, and removed once the models catch up.

How does US GAAP differ?

Under CECL in ASC 326, lifetime expected losses are recognised from day one for all assets in scope, with no stage 1; see IFRS 9 vs CECL. See IFRS vs US GAAP: the key differences.

Need help applying the standards?

Our Chartered Accountants help finance teams and students apply IFRS and US GAAP to real transactions.

Book a call Chat on WhatsApp

Questions people ask

What are the three stages of expected credit loss?

Stage 1 carries 12-month ECL; stage 2, after a significant increase in credit risk, carries lifetime ECL; stage 3, credit-impaired, carries lifetime ECL with interest on the net carrying amount.

What is the difference between 12-month ECL and lifetime ECL?

12-month ECL covers losses from defaults possible in the next 12 months; lifetime ECL covers defaults possible over the asset's whole life.

How is expected credit loss calculated?

Usually as probability of default x loss given default x exposure at default, discounted and weighted across economic scenarios.

When is credit risk presumed to have increased significantly?

When payments are more than 30 days past due, unless the company has reasonable evidence otherwise.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. IFRS Foundation: IFRS 9 Financial Instruments

Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.

IFRS 9The simplified approach: a provision matrix for receivablesIFRS 9IFRS 9 financial instruments explainedIFRS 9Classification and measurement under IFRS 9: business model and SPPI

More in IFRS 9

Previous in this topicAmortised cost and the effective interest method under IFRS 9TopicAll 8 guides in IFRS 9

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