Trade Finance ECL, post modeling adjustment and PD of forebearance

[MH123]

Hi All,

Quite urgent, if I may say.

I am looking at approaches to models for ECL estimation of trade finance deals/cases transactions.

There are two approaches, depending the financing compenent of the deal, summarised below:

Simplified model

• Required for trade receivables or contract assets that do not contain a significant financing component (or are accounted for under the one-year practical expedient as per IFRS 15)
  Optional for trade receivables or contract assets that do contain a significant financing component and lease receivables
  ECLs are measured at an amount equal to lifetime ECLs at initial recognition and throughout the life of the asset
  No need to track changes in credit risk of the asset
  Often use provisioning matrices that are based on historical data and adjusted for forward-looking information

General model

• Required for all financial assets that are not measured at fair value through profit or loss, except for those that are eligible for the simplified model
  ECLs are measured at an amount equal to 12-month ECLs if there has not been a significant increase in credit risk since initial recognition, or lifetime ECLs if there has been such an increase
  Need to assess at each reporting date whether the credit risk on the asset has increased significantly since initial recognition
  Often use valuation models that use probabilities of default, loss given default and exposure at default

Questions/Clarifications@
1- How accurate/correct is this table? Please feel free to correct and augment with what completes the picture.
2-Under the simplified model, it says " often use provisioning matrices that are based on historical data.." a) what happens in "not often" cases? b) what can be done in the absence of historical data? are we talking about historical default data (PDs Transitions)? or historical LGDs?
3-The General model is to be used for "all financial assets that are not measured at fair value through profit or loss". which financial assets are not measured at fair value through profit or loss; short list only plz?

Kind Regards and thank you in advance,

[pub_acco]

1. Looks good to me.
2. The simplified approach is generally intended for non-financial institutions that have little knowledge in ECLs but have a bunch of day-to-day trade receivables arising from their ordinary sale of goods and rendering of services. So if you get a "non often" case, you should be careful if you should apply the simplified approach. I think IFRS doesn't define the term "trade receivable", but it's generally understood as those arising from the ordinary course of business. For these reasons, corporates that apply the simplified model often don't even understand PD or LGD.
3. Loans provided for officers, employees, joint ventures, etc. Loans provided for customers not in the ordinary course of business. Held-to-maturity investments in government and corporate bonds. Guarantee deposits paid.

[MH123]

Thank you very much pub_acco,
this is really helpful.

Still the part on provisioning matrices based on historical data: b) what can be done in the absence of historical data? are we talking about historical default data (PDs Transitions)? or historical LGDs?


Kind Regards,

[MH123]

Thank you very much pub_acco,
this is really helpful.

Still the part on provisioning matrices based on historical data: b) what can be done in the absence of historical data? are we talking about historical default data (PDs Transitions)? or historical LGDs?


Kind Regards,

[pub_acco]

Take a look at IFRS 9.B5.5.35 and IFRS 9 IE Example 12. They don't even distinguish PD and LGD.

[MH123]

Thank you pub_acco

[JakobLavrod]

While the simplified method used often work with loss rates rather then PD and LGD, from a calculation point of view it can often be quite good to break these two factors up, by A) How many customers get late to a certain point (default), which describes the PD, B) What is the recovery on these defaulted customers (LGD). In particular if you rely on third party collection or similar for collection on defaulted accounts, the LGD will then be driven by the price you get from the debt collection agency.

[MH123]

Thank you Jakob,
Have a great day.