COVID-19: Impact on Expected Credit Losses

The COVID-19 pandemic has had a significant impact on economic activities and business operations in Canada and around the world. One of the impacts on financial institutions, including credit unions, is the uncertainty around estimating expected credit losses under the International Financial Reporting Standard 9 (IFRS 9).

In Canada, major banks have set aside billions of dollars during their second quarters to cover anticipated losses due to the pandemic. Both Royal Bank and BMO’s results showed their profits had been cut in half as loan loss provisions spiked by 500 percent. Canadian Imperial Bank of Commerce and Toronto-Dominion also missed earnings expectations due to billions set aside to cover future loan losses.

In total, loss provisions totalled almost $11 billion for six major Canadian banks. It is anticipated that Canada’s credit unions will see similar impacts as they progress through the remainder of the year.

This article is intended to touch on some of the challenges posed by the pandemic on the subsequent measurement of financial instruments relating to expected credit loss (ECL) estimates and on current assumptions set in the impairment modelling tools and disclosures.

Then and Now

While IFRS 9 required an allowance to be recognized when the financial instrument experienced a significant increase in credit risk (SICR), allowances were based on a lifetime of expected losses. “However, it does not set bright lines or a mechanistic approach to determining when lifetime losses are required to be recognized. Nor does it dictate the exact basis on which entities should determine forward-looking scenarios to consider when estimating ECLs,” the International Accounting Standards Board stated in a March 2020 guidance on COVID-19 and IFRS 9.

The application of the standard requires entities to use significant judgement in their approach to determine ECLs, which is influenced by circumstances around the loss. This principle-based approach uses several assumptions, judgments and factors in implementing a model or technique to estimate ECLs. These assumptions and factors may no longer hold in the current environment.

“Entities should not continue to apply their existing ECL methodology mechanically. For example, the extension of payment holidays to all borrowers in particular classes of financial instruments should not automatically result in all those instruments being considered to have suffered a SICR,” the board stated.

Canadian Regulatory Support

In response to the growing uncertainty and impact of the pandemic on financial institutions, Canada’s Office of the Superintendent of Financial Institutions (OSFI) announced several measures in March 2020 to reduce operational stress.

 Key measures included:

• Adjusting capital and liquidity measures.
• Delaying implementation of the remaining measures of the Basel III international capital standard until 2023.
• Determining under regulatory capital requirements that bank loans subject to payment deferrals, such as mortgage loans, small business loans and retail loans, will continue to be treated as performing loans.
• Delaying the implementation of revised minimum capital and liquidity requirements for small- and medium-sized banks until 2023.
• Providing guidance on applying IFRS 9.

Also, OSFI established capital and liquidity buffers and lowered the Domestic Stability Buffer improving the lending ability of lenders.

Continuous Monitoring

There is a need to continuously consider and assess the implication of the changes in macro-economic factors on the impairment model, how applicable existing assumptions are and required reporting. With the requirement to ensure inputs into the ECL model are reasonable and supportable, there is the need to ensure that assumptions are appropriate.

Process owners should reach out to their external auditors / advisors for guidance where needed.

Conclusion

The key to measuring ECL estimates in this COVID-19 reality is not to apply IFRS 9 mechanically. Instead, incorporate all reasonable and supportable information available when estimating ECL on loans. It is also important to continue to recognize regional and provincial economic differences, which inform your model and assumptions.

In light of the current economic changes, IFRS 9 and its associated disclosures can provide increased transparency and value-add information for users to better understand how credit unions and other users of financial statements have reflected the impact in its financial information.

For questions on this article contact Busola Fagbebe at [email protected].

For more information on IFRS 9 contact:

Annette Bester, CPA, CA
Partner, National Leader, Credit Union Services
306.664.8327
[email protected]

Curt Wagner, CPA, CA
Partner, Assurance and Accounting
306.664.8250
[email protected]