IFRS 9

IMPLEMENTATION GUIDANCE

JANUARY 2019

Plot 42 Bukoto Street, Kololo, P.O. Box 12464, Kampala, Uganda

Tel. 041-4540125, 031-2262333, 031-2265590, Fax: 041-4540389
[email protected], [email protected]
www.icpau.co.ug
 TABLE OF CONTENTS
1.0 INTRODUCTION ........................................................................ 6
2.0 SALIENT MODELLING PRINCIPLES ILLUSTRATED .................................. 7
3.0 DEFAULT .............................................................................. 18
4.0 PROBABILITY OF DEFAULT ......................................................... 23
5.0 EXPOSURE – (I) PERIOD OF EXPOSURE AND (II) EXPOSURE AT DEFAULT .... 28
6.0 LOSS GIVEN DEFAULT ............................................................... 32
7.0 DISCOUNTING ........................................................................ 35
8.0 MACRO-ECONOMIC FORECASTS AND FORWARD-LOOKING INFORMATION ... 37
9.0 IFRS 9 - ORGANISATION IMPLEMENTATION PLAN ............................... 42
10.0 IMPACT OF TRANSITION WITHIN THE BANKING SECTOR ......................... 7
APPENDIX: ILLUSTRATIVE CALCULATIONS FOR ECL .................................... 46

ICPAU Implementation Guidance on IFRS 9 Page 2 of 48

ABOUT ICPAU
The Institute of Certified Public Accountants of Uganda (ICPAU) was established in 1992 by
an Act of Parliament now the Accountants Act, 2013. The functions of the Institute, as
prescribed by the Act, are:
(i) To regulate and maintain the standard of accountancy in Uganda.
(ii) To prescribe and regulate the conduct of accountants and practicing accountants in
Uganda.

Vision
To be a world-class professional accountancy institute.

Mission
To develop, promote and regulate the accountancy profession in Uganda and beyond.

Core Values

1) Professional Excellence.
2) Accountability
3) Integrity.
4) Innovation

International Affiliations

The Institute is a member of the International Federation of Accountants (IFAC), the Pan
African Federation of Accountants (PAFA) and the Association of Education Assessment in
Africa (AEAA).

ICPAU Implementation Guidance on IFRS 9 Page 3 of 48

PURPOSE

This Guidance has been designed to assist accountants in business and industry
comply with the requirements of IFRS 9. The Guidance also intends to give practicing
accountants an appreciation of the requirements around IFRS 9 to enable them
easily review the business models and assumptions adopted by their respective
clients in application of the standard. The Guidance gives an analysis of the
requirements around the expected credit loss methodology, particularly on how
to measure ECLs, staging assessments and the possible approaches an entity may
apply depending on size and complexity of its transactions. Key definitions of such
terms like default, parameters that would guide in establishing probability of
default, exposure of an entity and the macro economic forecasts, are among other
aspects considered in this guidance. A brief assessment of the overall impact IFRS
9 may have on an entity’s governance framework is equally assessed in the
Guidance.

Whereas every effort has been taken not to design the Guidance with reference to
a particular sector, the impact of IFRS 9 is largely to be felt by the banking and
insurance sectors. We have incorporated a number of illustrations particularly from
the banking sector to enable a better appreciation of the concepts within the
standard.

ICPAU Implementation Guidance on IFRS 9 Page 4 of 48

DISCLAIMER

This Guidance is persuasive rather than prescriptive. The Guidance is not intended
to be comprehensive or to deal with all situations that might be encountered, i.e.
it is supplementary to and not a substitute for the International Financial Reporting
Standards (IFRS) and any other directives and Guidelines that may be developed
over time by ICPAU, which should be regarded as the primary source of guidance
for accountants. Accountants are encouraged to apply professional judgment in
complying with the requirements of IFRS 9.

ICPAU Implementation Guidance on IFRS 9 Page 5 of 48

1.0 INTRODUCTION
1.1 Background

On 24 July 2014 the IASB published the complete version of IFRS 9, ‘Financial
instruments’, which replaces most of the guidance in IAS 39. This includes amended
guidance for the classification and measurement of financial assets by introducing
a Fair Value through Other Comprehensive Income (FVTOCI) category for certain
debt instruments. It also contains a new impairment model which will result in
earlier recognition of losses. No changes were introduced for the classification and
measurement of financial liabilities, except for the recognition of changes in own
credit risk in other comprehensive income for liabilities designated at Fair Value
through Profit or Loss (FVTPL). It also includes the new hedging guidance that was
issued in November 2013. These changes are likely to have a significant impact on
entities that have significant financial assets including both financial and non
financial institutions.

IFRS 9 is much simpler than its predecessor IAS 39. It is principle-based and logical
rather than rule-based. It enables accounting to reflect the nature of the financial
asset (determined by its cash flow characteristics), the company’s business model
(how the assets are managed) and its risk management practice on financial
statements. It is forward-looking and ensures a more accurate, and timely
assessment of expected losses.

1.2 About IFRS 9

IFRS 9 stands on three main pillars which include:

Classification and measurement: This relates to how a financial asset is

accounted for in financial statements and how it is measured on an ongoing basis.
It requires an understanding of the characteristic of the financial asset and the
purpose of holding it. An entity must take into account whether the cash flows
generated from the instrument are solely payments of interest and principal, and
whether the entity intends to hold the asset to collect contractual cash flows or
both to collect contractual cash flows and for sale.

The standard introduces a cash flow and business model test that are typically
qualified by even trade receivables, debt instruments and loans to related parties
for a typical non financial institution. As such, these assets will require an
impairment assessment and subsequent adjustment to carrying values.

Equity and Derivatives will continue to be accounted for at fair value. Embedded
derivatives are no longer required to be separated from the Financial Assets.

Impairment: IFRS 9 replaces the incurred loss model used under IAS 39 with an
expected loss model. This significance of this amendment is that, on origination of

ICPAU Implementation Guidance on IFRS 9 Page 6 of 48

 a financial asset, an entity must recognise a 12-month expected credit loss and
subsequently recognise lifetime expected credit losses, if there has been a
significant increase in credit risk since initial recognition. Most important is that,
the expected credit loss model includes off-balance sheet items as well as sovereign
debt securities previously excluded in IAS 39 impairment computations. The single
impairment model is based on a forward-looking expected credit loss (ECL) model
that includes forward-looking information, such as macroeconomic forecasts, in
the computation of expected credit losses.

Hedge accounting: IFRS 9 allows more exposure to be hedged and provides for
principle-based requirements that are simpler than IAS 39 and aligned with an
entity’s risk management strategy.

2.0 SALIENT MODELLING PRINCIPLES ILLUSTRATED

2.1 Expected credit loss methodology

IFRS 9 introduces new impairment requirements that are based on a forward-

looking expected credit loss (ECL) model. In simple terms, it is the present value
of probability adjusted estimate of loss that would occur if the asset defaults.

IFRS 9 requires an entity to determine an expected credit loss (ECL) amount on a

probability-weighted basis as the difference between the cash flows that are due
to the entity in accordance with the contractual terms of a financial instrument
and the cash flows that the entity expects to receive. Although IFRS 9 establishes
this objective, it generally does not prescribe particular detailed methods or
techniques for achieving it.

In determining the cash flows that an entity expects to receive, many entities may
wish to adopt a sum of marginal losses approach whereby ECLs are calculated as
the sum of the marginal losses occurring in each time period from the balance
sheet date. The marginal losses are derived from individual parameters that
estimate exposures and losses in the case of default and the marginal probability
of default for each period (the probability of a default in time period X conditional
upon an exposure having survived to time period X). 1

ECL should therefore be based on the nature of the financial asset, financial
strength and credibility of the debtor, experience in dealing with similar assets,
current macroeconomic conditions, expectations of future trends and behavior,
forecasts of relevant variables and judgment.

In measurement of ECL, IFRS 9 requires that an entity’s ECLs should reflect:

 An unbiased and probability-weighted amount that reflects a range of
possible outcomes;
 Time value for money; and

1 GPPC P.21

ICPAU Implementation Guidance on IFRS 9 Page 7 of 48

  Reasonable and supportable information that is available without undue cost
or effort about past events, current conditions and forecasts of future
conditions. [IFRS 9.5.5.17]

ECLs are a probability-weighted estimate of the present value of cash shortfalls

(i.e., the weighted average of credit losses, with the respective risks of a default
occurring in a given time period used as the weights). ECL measurements are
unbiased (i.e. neutral, not conservative and not biased towards optimism (best
case scenario) or pessimism-(worst case scenario)) and are determined by
evaluating a range of possible outcomes. [IFRS 9.B5.5.41-43, BC5.86]. A credit loss
is the difference between the cash flows that are due to an entity in accordance
with the contract and the cash flows that the entity expects to receive discounted
at the original effective interest rate. Because ECL considers the amount and
timing of payments, a credit loss arises even if the entity expects to be paid
in full but later than when contractually due.

Four basic components consistent with regulatory and industry best practices will
form a basis for calculation of ECL and these include:

 Probability of Default (“PD”) – This is an estimate of the likelihood of default

over a given time horizon.

 Exposure at Default (“EAD”) – This is an estimate of the exposure at a future

default date, taking into account expected changes in the exposure after the
reporting date, including repayments of principal and interest, and expected
drawdowns on committed facilities. Unlike before, entities like banks now need
to make provisions for unutilized lines for example, overdraft limits and bank
guarantees which are all off the balance sheet will need to be provided for.
 Loss Given Default (“LGD”) – This is an estimate of the loss arising on default.
It is based on the difference between the contractual cash flows due and those
that the lender would expect to receive, including from any collateral. It is
usually expressed as a percentage of the EAD. The LGD will always drop where
an entity has sufficient collateral and or insurance cover but automatically
taking in regard the ‘time to realization’, impact of legal process in expending
the collateral, value of the collateral among others.

 Discount Rate – This is used to discount an expected loss to a present value at

the reporting date using the effective interest rate (EIR) at initial recognition.

An entity should regularly review their methodology and assumptions to reduce

any differences between the estimates and actual credit loss experience. [IFRS
9.B5.5.52]

ICPAU Implementation Guidance on IFRS 9 Page 8 of 48

2.2 Measuring ECLs

ECLs are generally measured based on the risk of default over one of two different
time horizons, depending on whether the credit risk of the borrower has increased
significantly since the exposure was first recognised. The loss allowance for those
exposures that have not increased significantly in credit risk (‘stage 1’ exposures)
is based on 12-month ECLs. The allowance for those exposures that have suffered
a significant increase in credit risk (‘stage 2’ and ‘stage 3’ exposures) is based on
lifetime ECLs.

IFRS outlines a ‘three stage’ model for provision/impairment based on changes in

credit quality since the day the loan was extended.

Change in credit quality since initial recognition

Stage 1 Stage 2 Stage 3

Performing Underperforming Non-Performing

(Initial recognition) (Assets with significant increase in (Credit-impaired assets)
credit risk since initial recognition)͓͓

Recognition of expected credit losses

12- Month ECL Lifetime ECL Lifetime ECL

Interest revenue

Effective interest on Effective interest on

Effective interest on amortised cost carrying
gross carrying amount gross carrying amount amount (i.e. net of
credit allowances)
Figure 1: The three-stage model for impairment

Stage 1 includes financial instruments that have not had a significant increase in
credit risk since initial recognition or that have low credit risk at the reporting
date. Most exposures will initially be in Stage 1. The entity recognises only
the credit loss associated with the probability of default within the next 12
months as a provision against the financial asset. At initial recognition, the
financial assets have low credit risk. Interest is accrued on the g r o s s carrying
amount of the instrument and a 12-month expected credit loss (ECL) is factored
into the profit or loss (P/L) calculations.

12- month ECL are the expected credit losses that result from those default
events on the financial asset that are possible within 12 months after the reporting
date. It is the entire credit loss on the instrument weighted by the
ICPAU Implementation Guidance on IFRS 9 Page 9 of 48
probability that the loss will occur in the next 12 months, not the expected
cash shortfalls over the 12-month period.

Stage 2 – includes financial instruments that have had a significant increase in

credit risk since initial recognition (unless they have low credit risk at the
reporting date) but that do not have objective evidence of impairment. As soon as
the exposure has suffered a significant increase in credit risk, the entity
recognises an allowance equal to expected credit losses over the lifetime
of the financial instrument. Interest is still accrued on the gross carrying
amount, but a lifetime ECL is factored into the profit or loss calculations.
Lifetime expected credit losses are expected credit losses that result from all
possible default events over the life of the financial asset. If for example a
mortgage loan has an expected life of loan maturity of 25 years ECL, and it
has gone into stage 2, one has to provide for over 25 ECL, instead of 12
months.

An asset moves from 12-month expected credit losses (stage 1) to lifetime expected
credit losses (stage 2) when there has been a significant deterioration in credit
quality since initial recognition. Hence the ‘boundary’ between 12-month and
lifetime losses is based on the change in credit risk not the absolute level of risk
at the reporting date. The expected loss over the lifetime of a loan for
example is likely to be significantly higher than the expected loss for the
next 12 months.

Determining whether a significant increase in credit risk has occurred can

require considerable judgment. While the standard provides extensive
guidance on factors that should be considered, entities often will have to
establish an accounting policy as to when an increase in credit risk is
significant within the context of its own internal credit risk management
and reporting. The standard does not specify what constitutes a significant
increase in credit risk but presumes that there is a significant increase in
credit risk since initial recognition if a loan facility for example, is more
than 30 days past due.

Stage 3 comprises financial assets that demonstrate evidence of

impairment (credit impaired instruments) at the reporting date and for
such, interest is accrued on the net carrying amount (net of provisions) and
a lifetime ECL is factored into the profit or loss calculations.(IFRS 9.A)

The standard includes a rebuttable presumption that a default does not

occur later than when a loan asset is 90 days past due. Entities have to
establish their own policies for what they consider as default and apply
that d e f i n i t i o n consistently with that used for internal credit
risk management purposes including consideration of qualitative factors
such as;
ICPAU Implementation Guidance on IFRS 9 Page 10 of 48
 - Breaches of contracts e.g. past due or default
- Significant financial difficulty of the counterparty, etc.
Whereas an entity may place credit exposures without significant increase in credit
risk, in the 12 months ECL level irrespective of the counter party[s credit risking
rating at origination, if the credit risk increases the relevant credit risk exposures
must transition to lifetime ECL.

It is equally possible for an instrument for which lifetime expected credit losses
have been recognised to revert to 12-month expected credit losses should the
credit risk of the instrument subsequently improve so that the requirement for
recognising lifetime expected credit losses is no longer met. There is however,
need for supportable evidence that both quantitative and qualitative criteria for
categorization under either significant increase in credit risk or default have ceased
to exist and this should be accompanied by monitoring of the behavior of a particular
credit exposure over a reasonable period of time. The duration to be considered
for curing the asset from higher risk stages to lower risk stages should explicitly be
provided for in the entity’s risk management policies and clearly defined for
each type of asset or asset segment.

For Noting:
The ECL model relies on a relative assessment of credit risk. This means that a loan with
the same characteristics could be included in Stage 1 for one entity and in Stage 2 for
another, depending on the credit risk at initial recognition of the loan for each entity.

Historical information is key in ECL. However, an entity needs to adjust such historical
data, like credit loss experience, on the basis on observable data to reflect the effects of
the current conditions and its forecasts that did not affect the period on which the
historical data is based. Therefore an entity must put in place mechanisms or frameworks
to ensure that ECL models are reviewed periodically so that differences between loss
estimates and actual losses are minimized. The supervised financial institutions (Banks)
are required to review the ECL models at least annually.

Moreover, an entity could have different loans with the same counterparty that are
included in different stages of the model, depending on the credit risk that each loan had
at origination.

By principle, with the lifetime ECL, 15 year loan term versus a 5 year loan will carry
different provisioning with the loan of a longer tenure having a higher provisioning than
the one with a shorter tenure.

ICPAU Implementation Guidance on IFRS 9 Page 11 of 48

 For restructured credit exposures that show evidence of reduction in credit risk, an entity
(more so for Banks) should monitor those credit exposures for at least 12 calendar months
before upgrading such exposures from higher to lower risk stages.

2.3 Staging assessment

In order to assess both the staging of exposures and to measure a loss allowance on
a collective basis, an entity groups its exposures into segments on the basis of
shared credit risk characteristics.

Examples of shared characteristics include: geographical region, type of customer

(such as wholesale or retail), industry, product type (such as ‘normal’ repayment
mortgages, interest-only mortgages and mortgages on rented property), customer
rating, date of initial recognition, term to maturity, the quality of collateral and
the loan to value (LTV) ratio. The different segments reflect differences in PDs
and in recovery rates in the event of default. To assess the staging of exposures,
the grouping of exposures also takes into account the credit quality on origination
in order to identify deterioration since initial recognition. [IFRS 9 B5.5.5]

The entity performs procedures to ensure that the groups of exposures continue to
share credit characteristics, and to re-segment the portfolio when necessary, in
the light of changes in credit characteristics over time. The staging assessment
also drives how exposures will be disclosed in the notes to the financial
statements.

2.4 Collective calculations and segmentation

ECLs on individually large exposures and credit-impaired loans are generally

measured individually. For retail exposures and many exposures to small and
medium-sized enterprises, where less borrower-specific information is available,
ECLs are measured on a collective basis. This incorporates borrower-specific
information, such as delinquency, collective historical experience of losses and
forward-looking macroeconomic information.
2.5 Implementation hurdle

When estimating ECL, management should consider information that is reasonably

available, including information about past events, current conditions and
reasonable and supportable forecasts of future events and economic conditions.
Reasonable and supportable information will not generally present itself to
management as such – rather management will need to determine what is relevant
in the context of the impairment requirements and to actively gather and analyse
data and use it to make estimates. 2 The degree of judgement that is required for
the estimates will hence depend on the availability of detailed information.

2 Possible sources of data include: internal historical credit loss experience, internal ratings, credit loss
experience of other entities, external ratings, reports and statistics. Where an entity does not have sufficient

ICPAU Implementation Guidance on IFRS 9 Page 12 of 48

The information used is required to reflect factors that are specific to the borrower,
general economic conditions and an assessment of both the current as well as the
forecast direction of conditions at the reporting date. Information that is available
for financial reporting purposes is always considered to be available without undue
cost or effort.

For entities like a bank, impairment is an area of high estimation uncertainty that
is typically material to the bank’s financial statements. Judgments made in applying
accounting policies for impairment are typically complex and have a significant
effect on amounts recognised in the financial statements. Care is required before
determining that the acquisition or development of apparently relevant
information is unduly burdensome. Remember application of IFRS 9 is subject
to the concept of materiality and it should be applied to all material portfolios.
The materiality of portfolios and exposures and the related risks of material
misstatement therefore will also be a factor in management’s selection of an
approach and the design of related internal controls. However, this should not
result in individual exposures or portfolios being considered immaterial if
cumulatively they represent a material exposure.

For periods beyond ’reasonable and supportable forecasts’, management should

consider how best to reflect its expectations by considering information at the
reporting date about the current conditions, as well as forecasts of future events
and economic conditions. As the forecast zones increase, the availability of detailed
information decreases, and the degree of judgement to estimate ECL increases.
The estimate of ECL does not require a detailed estimate for periods that are far
in the future – for such periods, management may extrapolate projections from
available, detailed information

In determining requirements for a particular portfolio an entity may wish to

consider the following factors as guidance:

Entity-level factors
 Extent of systemic risk posed by the entity, as indicated by categorisation or
extent of regulatory supervision.
 Listing status and distribution of ownership of issued debt and equity
securities
 Status as a public interest entity
 Total size of balance sheet and off-balance sheet credit exposures
 Level and volatility of historical credit losses

Portfolio-level factors
 Size of portfolio, relative to the entity’s total balance sheet and credit
exposures
 Complexity of products in the portfolio

sources of entity-specific data of its own, it may use peer group experience for comparable financial
instruments.

ICPAU Implementation Guidance on IFRS 9 Page 13 of 48

  Sophistication of other lending-related modeling methodologies, such as
regulatory capital methodology (i.e. Advanced Internal Rating Based (IRB)
Model, Foundation IRB or Standardised), stress testing methodology, pricing
methodology, etc.
 Extent of relevant data available for the portfolio but not restricted solely to the
data the entity currently has.
 Level of historical credit losses experienced on the portfolio.
 Level and volatility of potential future credit losses from the portfolio.
2.6 Suggested Approaches to ECL

Due to expected challenges above, we suggest the following approaches to ECL

that will be simpler. See Example 2 in the Appendix for reference.
2.6.1 Term to maturity approach

This approach does not estimate PD, EAD and LGD for separate time intervals over
the term of the loan but, instead, uses a single measure of each for the remaining
term in order to measure lifetime ECLs. This is easier to apply than a more
sophisticated approach, but is more suited to exposures that are non-amortising
and cannot be prepaid (so that assumptions about the EAD are a less significant
variable) and shorter term (so that assumptions about when during the term a
borrower is more likely to default and the effect of discounting are less significant).
2.6.2 Loss rate approach

Using a ‘loss rate’ approach, the PD and LGD are assessed as a single combined
measure, based on past losses, adjusted for current conditions and forecasts of
future conditions. It may be easier to use when there is insufficient data to
measure the separate components. This approach is, as with the term to maturity
approach, more suited to exposures that are non-amortising and shorter term.
Although an adjusted loss rate approach may be used to measure ECLs, an entity
needs to be able to separate the changes in the risk of a default occurring from
changes in other drivers of ECLs for the purpose of the staging assessment. [IFRS
9.B5.5.12]

2.6.3 Segment parameters

Whereas, in a sophisticated approach, individual exposures within a group of

exposures used for measurement of ECLs will each be assigned an individual PD, it
is possible that a single PD and LGD might be applied to all exposures in the
segment. This is likely to be appropriate only when segments are sufficiently
granular that there is no reason to believe, based on reasonable and supportable
evidence, that the individual exposures do not share a similar PD or LGD.

A simpler approach is not necessarily a lower quality approach if it is applied to an

appropriate portfolio of credit exposures. Irrespective of where a portfolio is
positioned overall on the sophistication spectrum, the approach must comply with
IFRS 9, and therefore not be designed or implemented to introduce material bias.
It may not be necessary for every single component of the ECL approach (for

ICPAU Implementation Guidance on IFRS 9 Page 14 of 48

 example, probability of default (PD) model, staging assessment, segmentation,
etc.) to be at the same level of sophistication as indicated for the portfolio
overall.

However, management would be expected to provide particular justification for

the use of any individual components with a much lower level of sophistication
than is indicated for the portfolio overall. Management will also need to consider
how disclosures will adequately describe the use of different approaches to users
of the financial statements.

An entity will need to monitor whether its approaches continue to be appropriate

in light of changes in circumstances after transition and have internal controls to
ensure that this objective is achieved.

In particular, there may be improvements in the availability of data or in

understanding the relationship between data and credit losses that may allow the
adoption of more sophisticated modeling. Our expectation is that over time,
entities will make enhancements to better implement the requirements of IFRS 9
as the availability of data improves.

2.6.4 Exception from the ‘three stage’ general model

We refer to the model described above as the ‘general approach’. However, there
are circumstances to which this general may not apply:

 a simplified approach for trade receivables, contract assets and lease

receivables;
 an approach for purchased or originated credit-impaired financial assets; and
 financial instruments with low credit risk.
2.7 Simplified approach for trade and lease receivables

The model includes some operational simplifications for trade receivables,

contract assets and lease receivables, because they are often held by entities that
do not have sophisticated credit risk management systems. For trade receivables
or contract assets that do not contain a significant financing component, the loss
allowance should be measured at initial recognition and throughout the life of the
receivable at an amount equal to lifetime ECL.

A key advantage of this simplified approach is that an entity is not required to

determine whether credit risk has increased significantly since initial recognition.
Instead a loss allowance is recognised based on lifetime expected credit losses at
each reporting date. As a practical expedient, a provision matrix may be used to
estimate ECL for these financial instruments. See Example 1 in the Appendix for
reference.

ICPAU Implementation Guidance on IFRS 9 Page 15 of 48

 Trade
receivables or
contract assets Simplified
approach: ECL Lifetime
that don’t expected credit
contain a losses
significant
financing

For trade receivables or contract assets which contain a significant financing

component in accordance with IFRS 15 and lease receivables, an entity has an
accounting policy choice: either it can apply the simplified approach (that is, to
measure the loss allowance at an amount equal to lifetime ECL at initial
recognition and throughout its life), or it can apply the general model.

Lifetime
Simplified
expected
approach:
credit losses
Trade ECL
receivables or
contract assets
that contain a Policy
significant Choice
financing
component +
ECL Monitor
significant
increases in
credit risk

2.8 Purchased or originated credit-impaired assets

A financial asset is considered credit-impaired on purchase or origination if there is

evidence of impairment (IFRS 9 Appendix A) at the point of initial recognition.
Evidence that a financial asset is credit-impaired includes observable data about
the following events:
 significant financial difficulty of the issuer or the borrower.
 a breach of contract, such as a default or past due event.
 the lender(s), for economic or contractual reasons relating to the borrower’s
financial difficulty, having granted to the borrower a concession(s) that the
lender(s) would not otherwise consider.
 it is becoming probable that the borrower will enter bankruptcy or other
financial reorganization.
 the disappearance of an active market for the financial asset because of
financial difficulties.
 the purchase or origination of a financial asset at a deep discount that reflects
the incurred credit losses.
Under this specific approach, an entity is required to apply the credit-adjusted
effective interest rate to the amortised cost of the financial asset from initial

ICPAU Implementation Guidance on IFRS 9 Page 16 of 48

 recognition. Thereafter it only recognizes the cumulative changes in lifetime
expected credit losses since initial recognition as a loss allowance that is
impairment is determined based on full lifetime ECL on initial recognition. The
amount of the change in lifetime expected credit losses is recognized in profit or
loss as an impairment gain or loss.

Unlike other financial assets, gains on purchased or originated credit-impaired

assets are not limited to the reversal of previously recognised impairment losses.
Instead an improvement in credit quality beyond that which was estimated at the
time of initial recognition, results in impairment gains being recognised in profit or
loss.

2.9 Financial Instruments with low credit risk

As an exception to the general model, if the credit risk of a financial instrument is

low at the reporting date, management can measure impairment using 12-month
ECL, and so it does not have to assess whether a significant increase in credit risk
has occurred. In order for this operational simplification to apply, the financial
instrument has to meet the following requirements:
(a) it has a low risk of default;
(b) the borrower is considered, in the short term, to have a strong capacity to
meet its obligations; and
(c) the lender expects, in the longer term, that adverse changes in economic
and business conditions might, but will not necessarily; reduce the ability of
the borrower to fulfil its obligations. [IFRS 9.B5.5.22]

The credit risk of the instrument needs to be evaluated without consideration of

collateral. This means that financial instruments are not considered to have
low credit risk simply because that risk is mitigated by collateral. Financial
instruments are also not considered to have low credit risk simply because they
have a lower risk of default than the entity’s other financial instruments or relative
to the credit risk of the jurisdiction within which the entity operates. [IFRS
9.B5.5.22]
Financial instruments are not required to be externally rated. An entity can use
internal credit ratings that are consistent with a global credit rating definition of
‘investment grade’. [IFRS 9.B5.5.23]
The low credit risk simplification is not meant to be a bright-line trigger for the
recognition of lifetime ECL. Instead, when credit risk is no longer low,
management should assess whether there has been a significant increase in credit
risk to determine whether lifetime ECL should be recognized. This means that
just because an instrument’s credit risk has increased such that it no longer
qualifies as low credit risk, it is not automatically included in Stage 2,
Management needs to assess if a significant increase in credit risk has occurred
before calculating lifetime ECL for the instrument. [IFRS 9.B5.5.24]

ICPAU Implementation Guidance on IFRS 9 Page 17 of 48

 For Noting:
 The use of the practical expedient for financial assets with low credit risk is
optional. That is, management can choose to apply the general model for those
assets.
 It is expected that this operational simplification will provide relief to entities
especially financial institutions, such as insurers, who hold large portfolios of
securities with high credit ratings. This expedient will avoid having to assess
whether there are significant increases in credit risk for financial assets with low
credit risk.

What is not Compliant?

(a) Using fair value models to estimate ECLs without appropriately adjusting for
changes in market rates of interest and yields that should not be reflected in
ECLs. [IFRS 9.A (definition of credit loss), IFRS 9.BC5.123]
(b) Using expected losses as calculated for regulatory purposes without assessing
whether any adjustments are required to reflect the requirements of IFRS 9.
[IFRS 9.5.5.17(c), B5.5.49-54, BC5.283]
(c) Groupings of exposures for collective assessment and measurement that result
in segments that do not share credit risk characteristics such that changes in
credit risk in a part of the portfolio may be masked by the performance of
other parts of the portfolio. [IFRS 9.B5.5.5, GCRAECL.A11-12]
(d) Excluding the effects of contractual repayments and expected prepayments on
loans, and of expected drawdowns on committed facilities. [IFRS 9.B5.5.30-31,
51]
3.0 DEFAULT
IFRS 9 explains that changes in credit risk are assessed based on changes in the risk
of a default occurring over the expected life of the financial instrument (the
assessment is not based on the amount of expected losses). ‘Default’ is not itself
actually defined in IFRS 9 however, the standard seems to indicate that default
takes place no later than 90 days past due. (Global Public Policy Committee,
2016). Whereas an entity must instead reach their own definition of default, the
Standard provides that the definition must be consistent with the following:

(a) the entity’s internal definitions of default based on its internal risk
management guidelines e.g. as contained in credit policies or board approved
guidelines.
(b) Regulator definitions of default.
(c) Credit impaired financial assets definition.

Once determined, the definition shall be applied consistently to all financial

instruments unless information becomes available that shows another definition is
more appropriate for a particular financial instrument. Under IFRS 9 (Appendix A),

ICPAU Implementation Guidance on IFRS 9 Page 18 of 48

 a financial asset is credit-impaired when one or more events have occurred and
have a significant impact on the expected future cash flows of the financial asset.
It includes observable data that has come to the attention of the holder of a
financial asset that could indicate impairment.

3.1 Challenges

a. There are likely to be differences in the definition of default for regulatory

purposes and per the IFRS resulting in some assets that may be considered by
the regulator to be in default but not in default as per the IFRS 9 and vice
versa. (Global Public Policy Committee, 2016). Under the Financial Institutions
Act (FIA), 2014, Banks are required to write off loss assets against accumulated
provisions within 90 days of being identified as loss, unless approval of the
central bank to defer write-off has been obtained. Contrary to this, the IFRS 9
allows for assets to remain on the books if the institution deems the asset still
recoverable. This partly explains why in the Central Bank’s assessment of
reports submitted by Banks as at June 2018, the industry provisions computed
under IFRS 9 were USh.683.5 billion while required provisions under FIA were
USh.461.9 billion, giving a difference of Ush.221.5 billion. 3

b. For banks, the regulator has a provision for statutory reserves to account for
the differences. However, more disputes with tax authorities are expected
since the regulators definition of default does not factor expected default but
only considers default when it has occurred. The tax authority may be required
to advise.

c. Data to determine whether an asset is likely to be credit impaired /predict

future may not be easily available eg a borrower may be in financial difficulties
which becomes evident only on default.
d. Determining the probability/likelihood of impairment for particular portfolios
or individual loans may be difficult due to data unavailability or data
inaccuracy.

e. Before the models become well refined as the IFRS 9 is better understood,
impairment provisions may fluctuate significantly year to year thus making
financial performance difficult to measure for individual institutions and also
making it difficult to compare peer institutions since each institution may have
its own definition of default.

f. For entities with diverse and more complex credit products, their models need
to be more sophisticated and will require expertise to develop and refine later
so as to more accurately reflect differing characteristics of the financial
instruments. This is at a financial cost if there are no in house skills. Smaller

3 Bank of Uganda, Financial Stability Report, June 2018

ICPAU Implementation Guidance on IFRS 9 Page 19 of 48
 institutions may find it even hard to develop models to determine impairment
as per the IFRS 9.

g. Institutions may have to invest more in their systems to cater for increased
customer/portfolio data capture and retention requirements.

3.2 Suggested approach

(d) Entities can opt to use either the sophisticated or simpler models (Global Public
Policy Committee, 2016).
(e) For entities using the sophisticated approach, they should analyse both
definitions of default by the IFRS and the regulator and apply a consistent
single definition of default for both regulatory and financial reporting purposes
and if not, document the reasons. (Global Public Policy Committee, 2016)
(f) Entities may opt to use simple models developed for regulatory purposes using
the definition of default used in the models but however adjust the model for
the effect of the differences between the regulatory and accounting
definitions. If differences are believed to result in immaterial outcomes, the
entity should be able to support this view. (Global Public Policy Committee,
2016)
(g) IFRS 9 paragraph 5.5.1 requires that the same impairment model apply to all of
the financial assets measured at amortised cost and at Fair value through Other
comprehensive income (FVTOCI) and Loan commitments when there is a present
obligation to extend credit (except where these are measured at Fair value
through profit or loss (FVTPL). (Deloitte, 2017)
(h) In summary Impairment of financial assets is recognised in 3 stages as follows
(IFRS Foundation, 2017):
Stage 1—as soon as a financial instrument is originated or purchased, 12-
month expected credit losses are recognised in profit or loss and a loss
allowance is established. This serves as a proxy for the initial expectations
of credit losses. For financial assets, interest revenue is calculated on the
gross carrying amount (i.e. without deduction for expected credit losses).

Stage 2—if the credit risk increases significantly and is not considered low,
full lifetime expected credit losses are recognised in profit or loss. The
calculation of interest revenue is the same as for Stage 1.

Stage 3—if the credit risk of a financial asset increases to the point that it is
considered credit-impaired, interest revenue is calculated based on the
amortised cost (i.e. the gross carrying amount less the loss allowance).
Financial assets in this stage will generally be assessed individually. Lifetime
expected credit losses are recognised on these financial assets.

ICPAU Implementation Guidance on IFRS 9 Page 20 of 48

3.3 General approach (IFRS 9 paragraphs 5.5.3 and 5.5.5)

With the exception of purchased or originated credit impaired financial assets

expected credit losses are required to be measured through a loss allowance at an
amount equal to:
 the 12-month expected credit losses (expected credit losses that result from
those default events on the financial instrument that are possible within 12
months after the reporting date); or
 full lifetime expected credit losses (expected credit losses that result from all
possible default events over the life of the financial instrument).
 A loss allowance for full lifetime expected credit losses is required for a
financial instrument if the credit risk of that financial instrument has increased
significantly since initial recognition, as well as to contract assets or trade
receivables that do not constitute a financing transaction in accordance with
IFRS 15. [IFRS 9 paragraphs 5.5.3 and 5.5.15]
 Additionally, entities can elect an accounting policy to recognise full lifetime
expected losses for all contract assets and/or all trade receivables that do
constitute a financing transaction in accordance with IFRS 15. The same election
is also separately permitted for lease receivables. [IFRS 9 paragraph 5.5.16]
 For all other financial instruments, expected credit losses are measured at an
amount equal to the 12-month expected credit losses. [IFRS 9 paragraph 5.5.5]

3.4 Exceptions

3.4.1 Purchased or originated credit-impaired financial assets (IFRS 9 paragraphs 5.5.13 –

5.5.14)
For these assets, an entity would recognise changes in lifetime expected losses
since initial recognition as a loss allowance with any changes recognised in profit
or loss. Under the requirements, any favourable changes for such assets are an
impairment gain even if the resulting expected cash flows of a financial asset
exceed the estimated cash flows on initial recognition.

For Noting
Not every entity needs to define ‘default’. For example, an entity whose
credit exposures are limited to trade receivables and contract assets (with no
significant financing component) would apply the simplified model as described
earlier.
However, ‘default’ is a key building block when applying the general (three-
stage) model because:
a) movement between the three stages is driven by changes in the risk of default
b) some entities estimate credit losses as the product of the probabilities
of various defaults (PDs) and the losses that would arise if those defaults
occur (‘loss given default’ or LGD)

ICPAU Implementation Guidance on IFRS 9 Page 21 of 48

Definitions of default used in practice fall into two very broad categories:
a) definitions based on contractual breaches such as failure to make a payment when
due or breaches of a covenant
b) more judgmental definitions based on qualitative factors. The most important point
is that the definition should be appropriate to the instrument. The illustrations
below give guidance on the various approaches to the definition of default.

Illustration 1 – Installment loan

Lender A makes a 7 year amortising loan with payments of principal and interest
payable in regular monthly instalments. The borrower is also subject to six-month
financial covenants. For this loan a definition of default based on missed payments
and covenant breaches could be suitable.

Illustration 2 – term loan

Lender B makes a 7 year loan with interest payable monthly and principal all due
on maturity. In this case it is unlikely that a definition of default that is based
solely on missed payments will be sufficient. This is because the main repayment is
not due until maturity and hence a definition based on late payment would not capture
the possibility that events take place before maturity that result in the borrower becoming
unlikely to repay.

Illustration 3 – Interaction with regulatory definitions of default

Some entities such as financial institutions may be the subject of regulation which
is designed to gauge their solvency.
The regulations affecting such entities will often contain a definition of default.
This leads to the question of whether the regulatory definition can be used for IFRS
9 purposes. The simple answer to this question is that regulatory definitions of
default can be used in so far as they do not conflict with the principles set out in
IFRS 9.

For supervised financial institutions, the BoU requires them to have documented
their quantitative and qualitative triggers based on forward looking information
that and the 30 days and 90 days past due presumption provided for in the
standard to be only applied as backstops when determining default. 4 However, a
more stringent measure is preferred in instances where there is a n apparent
contradiction between the backstops in the standard and the credit classification
criteria stipulated in the various laws regulating the banking sector.

4 BoU December 2018

ICPAU Implementation Guidance on IFRS 9 Page 22 of 48

 Illustration 4
An entity might wish to use a local regulator’s definition of ‘non-performing loans’ for
determining when it needs to transfer assets into and out of Stage 3 of IFRS 9’s
impairment model. Under the local regulator’s rules, a loan cannot be transferred
back to the portfolio of performing loans until at least 12 months have elapsed
from the point it was categorised as nonperforming.

On whether the regulator’s definition of non-performing loans be used as the basis for
making transfers into and out of Stage 3 of IFRS 9’s impairment model or not, it is
important to note that the regulator’s definition of non-performing loans may not be
appropriate for IFRS 9 purposes. IFRS 9 would require the asset to be transferred out
of stage 3 if the credit risk on the financial instrument improves so that the financial
asset is no longer credit-impaired. There is nothing in IFRS 9 to prohibit the transfer
out of stage 3 occurring sooner than 12 months after the transfer into stage 3. The
regulatory definition of non-performing loans may be a useful starting point in arriving
at a definition of default, but will probably need to be amended to comply with IFRS
9.

What is not compliant?

i. When models used to estimate default result in fewer default events than the
actual result of what is observed and monitored in the credit risk management by
the entity.
ii. Using information meant for regulatory purposes without making adjustments as
to whether the information is fit for use under IFRS 9.
iii. Not applying the 90 days past due back stop unless the entity has documented
reasonable and supportable information to justify a more lagging default criterion
(greater than 90 days) is appropriate.
4.0 PROBABILITY OF DEFAULT
Probability of default is an estimate of the likelihood of default of a financial
instrument over a given time horizon.

A number of entities tend to use PD’s as a key component both in calculating ECL’s
and in assessing whether a significant increase in credit risk has occurred. A PD
used for IFRS 9 should reflect management’s current view of the future and should
be unbiased. (I.e. it should not include any conservatism or optimism).

Two types of PD’s are used for calculating ECL’s:

(a) 12-month PD’s -This is the estimated probability of default occurring within the
next 12 months (or over the remaining life of the financial instrument if that is
less than 12 months). This is used to calculate 12 month ECL’s
(b) Life time PD’s-this is the estimated probability of default occurring over the
remaining life of the financial instrument. This is used to calculate life time
ECL’s for stage 2 and 3 exposures.

ICPAU Implementation Guidance on IFRS 9 Page 23 of 48

 PD’s may be broken down further into marginal probabilities for sub periods within
the remaining life.

4.1 Suggested approach and challenges

4.1.1 A sophisticated approach

PD’s are limited to the maximum period of exposure required by IFRS 9.

(a) 12-month PD’s

If an entity uses IRB models for regulatory purposes, the entity may use the
outputs from its IRB models as a starting point for calculating IFRS 9 PDs.
However, the PDs from these IRB models may in some organisations be determined
using a through the cycle (TTC) rating philosophy (or hybrid point- in-time
approach) or may include certain conservative adjustments (such as floors).
Therefore, these PDs are appropriately adjusted if they are to be used for IFRS 9
purposes. Examples of adjustments include:
 Conversion to an unbiased (rather than conservative) estimate.
 Removal of any bias towards historical data (for example, TTC) that does
not reflect management’s current view of the future.
 Aligning the definition of default used in the model with that used for
IFRS 9 purposes.
 Incorporating forward-looking information.

If an entity does not have IRB models, new models are developed to produce 12-
month PDs for IFRS 9 purposes. All key risk drivers and their predictive power
are identified and calibrated based on historical data over a suitable time period.
This could take the form of a scorecard approach. A scorecard approach uses a
set of loan-specific or borrower-specific factors which are weighted to produce
an assessment of credit risk.

(b) Lifetime PD’s

To determine lifetime PD’s, an entity either builds from the 12-month PD model or
develops a lifetime PD model separately.

If the entity builds from the 12-month PD model, it develops lifetime PD curves or
term structures to reflect expected movements in default risk over the lifetime of
the exposure.
This involves:
 Sourcing historical default data for the portfolio.
 Performing vintage analysis (performance comparisons between portfolio
segments where data is grouped based on the origination month) to understand
how default rates change over time.
 Extrapolating trends to longer periods where default data are not available for
the maximum period of exposure.
ICPAU Implementation Guidance on IFRS 9 Page 24 of 48
  Performing analysis at an appropriately segmented level, such that groups of
loans with historically different lifetime default profiles are modelled using
different lifetime default curves.
If an entity is able to incorporate detailed forecasts of future conditions in
developing PD estimates only for a period that is shorter than the entire
expected life, it applies a documented policy for determining the longer-term trend
in rates of default based on historical and other available reasonable and supportable
information. [IFRS 9.B.5.50, 52]
If an entity develops a new model to produce lifetime PD’s, it will be necessary to
ensure all key risk drivers and their predictive power are identified and calibrated
based on historical data over a suitable time period. This could take the form of a
scorecard approach.
4.1.2 Considerations for a simpler approach

(a) 12-month PD’s

Where there is insufficient default history for a particular portfolio (e.g. a

portfolio of new products), the entity uses internal benchmarking to a similar risk
portfolio, or a reduced level of risk segmentation (i.e. grouping similar risks /
portfolios to increase data credibility), and where relevant, uses external ratings
and external benchmarking.

There may be simpler alternatives to a scorecard approach available to the

entity. For example, adaptations of collective methodologies such as
roll/transition rates may be possible. Roll/transition rate methods are commonly
used under IAS39 to assess credit losses by analysing the movement of exposures
between different risk buckets (e.g. delinquency states) over time. Such
methods use historical observed rates to estimate the amounts of exposure that
are expected to roll into default over a specified period.

When an entity relies on external ratings, internal benchmarking or grouping risks

together, the entity should perform adequate analysis to justify this approach,
and consider and document its limitations. For example, grouping risks together
may mask underlying credit losses or increases in credit risks, if the segments are
not sufficiently homogeneous. Therefore, the entity should support the suitability
of any groupings of risks with sufficient evidence.

(b) Lifetime PD’s

An entity applies simpler extrapolation techniques to the 12-month PD. For
example, the entity may assume that the default rate does not change during the
lifetime of the loan or use less segmentation than under a more sophisticated
approach. This may be more common for shorter-term products.

ICPAU Implementation Guidance on IFRS 9 Page 25 of 48

 The entity should justify this approach with analysis evidencing that the PD
profiles are appropriately similar.

If an entity uses an extrapolation approach to determine lifetime PDs, then it may

combine different risk segments if they are considered to have similar lifetime
PD profiles.

This will simplify the modelling required and reduce the number of explicit PD
profiles to be calculated at each reporting date. The bank should justify this
approach with analysis supporting the assertion that the underlying PD profiles are
appropriately similar.

4.2 Challenges

(a) Limited use of effective interest rate

In Uganda, most entities particularly banks may lack the data capacity to
evaluate the effective interest rate of a loan. Most may not have a system in place
to monitor direct costs and costs that are attributable to credit risk, in order to
determine which costs should be amortized over the lifetime of the loan. The
entity would also need to model the costs of a loan for the period of the loan to
maturity in order to determine the effective interest rate.

A simplified approach that can be used may include making certain reasonable
assumptions e.g. management may assume the interest rate applied on a loan
approximates the effective interest rate and this is then used as the discount
factor. Over the lifetime of a loan, the most significant cost is the interest
expense so the effective interest rate would not be expected to differ significantly
from the interest rate of the loan instrument.
(b) Source of data for PD

The determination of the probability of default is largely determined by the

entity’s determination of “significant increase in credit risk”, based on both
qualitative and quantitative parameters. This then drives the staging criteria of
the loan which then flows into the PD calculation. The standard advocates for the
entity to determine the loan classification at the origination of the loan and then
review its loan classification at the reporting period. The movement noted would
then determine whether there has been a significant increase in credit risk. The
most significant limitation expected for local entities is that they may not have
developed an internal risk rating model that is applied to the loan portfolio. It
may therefore not be possible to determine what the original risk rating was for
a loan or the risk rating at the reporting date. For local Banks, the classification
being used is the Central Bank ratings of “Normal”, “Watch”, “Substandard”,
“Doubtful” and “Loss”. This rating is however, largely based on “days past due”,
which is the number of days a loan

ICPAU Implementation Guidance on IFRS 9 Page 26 of 48

repayment has been due for payment and the migration between buckets is
largely determined by the days past due. While this is an acceptable approach for
the standard, it is also very punitive.

The calculation of PD also requires loan classification data for the last two to three
years in order to determine the transition of the loan book between different
loan classifications. While most Banks may use the days past due approach to
calculate their PD’s currently, there are a few who do not have the historical
data required for modelling. This may poses a challenge as various assumptions
would need to be discussed to come up with a reliable probability of default for
different sectors of the portfolio.

(c) Lack of general models

IFRS 9 requires entities to now develop impairment models that not only
consider past and current events, but also future macro-economic information. Most
entities may not have an internal process in place to monitor future
macroeconomic information and how it affects the various portfolios the entity has.
This may require entities to put in place such processes internally, in the absence
of regular information from external sources.
The complexity of the IFRS 9 methodology may also require entities to consider
automation of the impairment process as this has largely been run manually in some
entities. The calculation of PD requires statistical modelling which may be easier
implemented in a more advanced system than manually (excel worksheets). Data
governance will also need to change in order to be able to implement this standard
with the least amount of effort on the entity. The data that is captured at
origination of a loan will need to be input in specific templates and the entity for
example Banks need to ensure there is a database in place to store historical data
for use in the impairment model.

For Banks, in the absence of historical data, the Banks may need to use proxy
information that is available publicly from the Central Bank until they can build
enough historical information to model internally. Examples of historical data
required are historical migration of loans between different classification buckets,
loan recoveries from the non-performing book in the past three to five years and
history of write-offs and any recoveries from the same.
What is not compliant?
 Leveraging existing models without, based on reasonable and
supportable information, validating that these models are fit for
purpose under IFRS 9 and/or making and documenting appropriate
adjustments. [IFRS 9.5.5.17(c), B5.5.49-54, BC5.283]

ICPAU Implementation Guidance on IFRS 9 Page 27 of 48

  Assuming a constant marginal rate of default over the remaining lifetime of a
product without appropriate supporting analysis. [IFRS 9.5.5.17(c), B5.5.49-54]
 Grouping together exposures that are not sufficiently similar. [IFRS 9.B5.5.5]

5.0 EXPOSURE – (I) PERIOD OF EXPOSURE AND (II) EXPOSURE AT DEFAULT

Exposure at Default (EAD) – an estimate of the loan exposure amount at a future
default date, taking into account expected changes in the exposure after the
reporting date. In practice, the estimation of EAD relates to contractual payment
terms including repayments of principal and payments of interest, any prepayments
or liquidations, expected drawdowns on committed facilities or any other term or
condition in favour of the obligor that may alter the cash flow characteristics of
the loan. It is an estimation of the entity’s exposure to its counterparty at the
time of default.

EAD is a key component of ECL calculations and understanding how loan exposures
are expected to change over time is crucial to an unbiased measurement of ECLs.
This is particularly important for 'stage 2' loans, where the point of default may be
several years in the future. While the relevance of EAD in assessing ECL is obvious,
estimating it is less so. For defaulted accounts, EAD is usually just the amount
outstanding at the point of default. However, for performing accounts, the
following elements are needed for computation of EAD under IFRS 9 at the
instrument/facility level:

 The exposure’s expected life

 Contractual payments of cash flows
 Prepayment or refinancing options and for revolving facilities an estimation of
credit conversion factors (CCFs). A CCF is a modeled assumption which
represents the proportion of any undrawn exposure that is expected to be drawn
prior to a default event occurring.
The EAD model therefore needs to consider forward looking information to
determine what the EAD would be at the time of a default and taking into account
the lifetime perspective (whole life) of a facility

It is also necessary to determine the period of exposure that is considered for IFRS 9
purposes. The period of exposure limits the period over which possible defaults are
considered and thus affects the determination of PDs and measurement of ECLs.
The discussion that follows here below illustrates how the period of exposure may
be determined and EAD may be calculated for IFRS 9 purposes.

ICPAU Implementation Guidance on IFRS 9 Page 28 of 48

 Challenges
(a) Period of exposure
Period of exposure may be difficult to determine for revolving facilities as this is based
on the behavioural life that could be longer than the contractual term.

(b) Exposure at default

The main challenge for an entity regarding EAD would be the limitation on historical
data to estimate assumptions e.g. on prepayments and refinancing.

5.1 Possible approaches

5.1.1 Period of Exposure
Expected life or period of exposure is equal to the maximum contractual period
over which the entity is exposed to credit risk. This maximum contractual period is
determined in accordance with the terms of the contract, including the entity’s
ability to demand repayment or cancellation, and the customer's ability to require
extension.
Revolving facilities
IFRS 9 expects lifetime expected loss modelling to extend beyond contractual
maturity for all revolving facilities. The period of exposure for these facilities is
based on their behavioural life.

For such facilities within the scope of IFRS 9.5.5.20 (i.e. that include both a loan
and an undrawn commitment component, and the entity’s contractual ability to
demand repayment and cancel the undrawn commitment does not limit the entity’s
exposure to credit losses to the contractual notice period), the period of exposure
is determined by considering the entity’s expected credit risk management actions
that serve to mitigate credit risk, including terminating or limiting credit exposure.

In doing this, the entity

 Considers how it mitigates credit risk, its past practice and future intentions and
expected credit risk mitigation actions.
 Analyses what happens in practice as a result of each of these types of
actions and demonstrates that there is sufficient historical evidence that such
actions are executed and impact the lifetime of the exposure. The analysis
should consider historical information and experience about the period over
which the entity was exposed to credit risk on similar instruments and the
length of time for defaults to occur on similar instruments following a
significant increase in credit risk. [IFRS 9.5.5.20, B.5.5.40]
A Practical approach to determining expected life could be the time taken for a
significant portion, e.g. 90% or 95%, of the loans to have defaulted, closed or
otherwise been derecognised. However, the remaining portion of the loans needs
ICPAU Implementation Guidance on IFRS 9 Page 29 of 48
 to be tested to show that it is not material.

For Noting
Defining the period of exposure to be:
(a) Shorter or longer than the maximum contractual period over which the entity
is exposed to credit risk (except for certain revolving credit facilities). [IFRS
9.5.5.19-20, B5.5.38]
(b) Equal to the historical average life of loans without checking consistency
with forward-looking expectations based on reasonable and supportable
information. [IFRS 9.5.5.17(c), B5.5.52]

For revolving credit facilities within the scope of IFRS 9.5.5.20:

(a) Using the legally enforceable contractual period unless analysis of historical
information shows that, in practice, management limits the period of exposure
to the contractual period. [IFRS 9.5.5.20, B5.5.39-40]
(b) Failing to consider all relevant historical information that is readily available
with minimal cost and effort when determining the exposure period [IFRS
9.5.5.17(c), B5.5.40]

5.1.2 Exposure at default

The modeling approach for EAD reflects changes that are expected in the balance
outstanding over the life of the loan exposure that are permitted by the current
contractual terms, including:
 Required repayments/amortisation schedule.
 Full early repayment (e.g. early refinancing).
 Monthly overpayments (i.e. payments over and above required repayments but
not for the full amount of the loan).
 Changes in utilisation of an undrawn commitment within agreed credit limits in
advance of default.
 Credit mitigation actions taken prior to default.
Non revolving credit facilities
The common approaches for such facilities include;
(a) Estimating repayment patterns from historical actual repayments. This
approach is very data dependent.
(b) Building loan amortisation models until contractual maturity, taking into
account unique characteristics of each facility, e.g. payment waiver for first
6 months. Additional assumptions are normally required for average arrears
age by Stage of loan e.g.

 All Stage 1 loans can be assumed to be up-to-date and the EAD used in
the ECL calculation lagged by three months with three months interest
added. A Stage 1 loan is assumed to default after three contractual
payments have been missed.
ICPAU Implementation Guidance on IFRS 9 Page 30 of 48
  Stage 2 loans can be assumed to be 1 month in arrears on average. The
EAD used in the ECL calculation is thus lagged by two months with two
months interest added. A Stage 2 loan is assumed to default after two
additional contractual payments have been missed.

(c) Back-testing results with the actual outstanding balances and making
necessary adjustments, e.g. for loan prepayments
The key considerations in this approach are:

 Loan level characteristics (product type, borrower income level, loan-to-

value)
 Linking PDs and LGDs to macroeconomic variable (interest
rates, unemployment rates, GDP, inflation)
 Additional loan features such as refinancing Revolving facilities:
The common approach for these facilities includes;
(1) Credit Conversion Factors where 12-month ECLs are calculated based on the
portion of the loan commitment that is expected to be drawn within 12
months of the reporting date while lifetime ECL is calculated based on the
portion of the loan commitment that is expected to be drawn over the
expected life of the loan commitment.
The key considerations in this approach are:
 Aggregation of data into homogenous risk groups
 Stability of development patterns and representativeness of historical
experience
EAD models are differentiated to reflect the different risk characteristics of
different portfolios. The entity considers these different underlying drivers in
determining the different inputs to EAD models. The inputs into the EAD model are
also reviewed to assess their suitability for IFRS 9 and adjusted, where required, to
ensure an unbiased ECL calculation reflecting current expectations and forward-
looking information.

5.2 Simplified approach

5.2.1 Period of exposure

If the period of exposure is taken to be less than the full period specified by IFRS
9, the entity should provide reasonable and supportable evidence that the impact
on ECLs of selecting this shorter period for the remaining balance is not material.

ICPAU Implementation Guidance on IFRS 9 Page 31 of 48

 All other principles detailed in the suggested approach also apply for simpler
implementations, although the level of detail required in addressing each principle
may be reduced.
5.2.2 Exposure at default

If an entity decides to use an approximation of the current 12-month EAD as

a proxy for the EAD over the remaining life, the entity should provide reasonable
and supportable evidence that this is appropriate for the specific product or
portfolio.

This is because a proxy may hold only for certain portfolios where the balance is
not anticipated to change significantly in the future.
Using segmented credit conversion factor (CCF) models could be appropriate if the
approach is justifiable with analysis showing that exposures within each CCF
segment are expected to behave similarly.
Under a simpler approach, an entity may use fewer levels of risk segmentation,
if it provides reasonable and supportable information evidencing that this is
appropriate.

For Noting
Using new or existing EAD models developed for other purposes such as regulatory
capital without demonstrating that these models are fit for purpose under IFRS 9,
including justifying and documenting the completeness and basis for inputs and
adjustments to inputs. [IFRS 9.5.5.17(c), B5.5.49-54, BC5.283]

Using 12-month EADs as a proxy for lifetime EADs without justification. [IFRS
9.B5.5.13-14, IFRS 9.5.5.17(c), B5.5.49-54]

6.0 LOSS GIVEN DEFAULT

This refers to the portion of asset(s) that’s lost when a borrower defaults. The
guiding principle of the expected loss given default model is to reflect the
general pattern of deterioration or improvement in the credit quality of financial
instruments.
The standard provides the basis upon which the model can be applied upon
consideration of portfolio coverage, underlying data, and establishment of
discounting factor among others. The principle is consistent with Basel core principles
on credit risk rating is developed as it considers all relevant and forward looking
information and macro-economic factors in assessing and measuring default.

IFRS-9 requires LGD’s to be lifetime (stage 2) upon significant increase in credit

risk.

ICPAU Implementation Guidance on IFRS 9 Page 32 of 48

6.1 Challenges
Likely challenges to be encountered in the implementation are listed as follows
 Unavailability of past data and forward looking information
 Training to the regulators, practicing accountants and reporting entities on
requirements of IFRS-9
 Non-Compliance with key regulatory ratios e.g. capital ratios due to
increased provisions. The BoU (June 2018) report notes that after
accounting for changes under IFRS 9, the industry core capital adequacy
ratio at June 2018 was 20.3 percent, compared to 19.9 percent under FIA.
The report further notes that the implication of the above impact should
only be taken as preliminary till a clearer picture on the impact of IFRS 9 on
capital and profitability will emerge once banks’ IFRS 9 accounts are audited
for compliance with reporting standards.
 Varying results where data applied is different, i.e. one institution may use
its specific data while another may adopt macro-economic data
 Significant increase in loan provisioning
 Inadequate disclosures hence compromising standardization and quality of
reports
 Dual provisioning framework on loans (performing, watch, substandard,
doubtful and loss)

6.2 Suggested approach

6.2.1 A sophisticated approach

The modelling approach for LGD (but not necessarily the actual LGD estimates)
generally does not vary depending on which stage the exposure is in, i.e. there is a
common LGD methodology that is applied consistently.
The modelling methodology for LGD is designed, where appropriate, at a
component level, whereby the calculation of LGD is broken down into a series of
drivers. This could be for example due to appreciation of various loans issued by a
financial institutions, i.e. collateralized and non-collateralized.

For secured (collateralized) exposures, the approach considers at a minimum the

following components:
 forecasts of future collateral valuations, including expected sale discounts;
 time to realisation of collateral (and other recoveries);
 allocation of collateral across exposures where there are a number of
exposures to the same counterparty (cross-collateralisation);
 cure rates (including consideration of how the entity has looked at re-
defaults within the lifetime calculation); and
 external costs of realisation of collateral including legal fees.

ICPAU Implementation Guidance on IFRS 9 Page 33 of 48

 For unsecured exposures the approach considers at a minimum the following
components:
 time to recovery;
 recovery rates; and
 cure rates (including consideration of how the entity has looked at re-
defaults within the lifetime calculation).
The estimation of the components should consider;
 the range of relevant drivers, including: geography (location of the
counterparty and the collateral) and seniority of the credit exposure.
 expected changes in the exposure (consistent with assumptions used in
modelling the EAD)
 whether component values are dependent on macro-economic factors
 whether there is any correlation or interdependency between components of
LGD so that the entity reflects that correlation in the estimation of LGD.
 That the data history that supports the modelling of LGD and its components
covers a suitable period to support the relevance and reliability of the
modelling (e.g. over a full economic cycle).
 the estimation of the component values within LGD reflects available historical
data
 whether there have been or are expected to be any changes in economic
conditions, or changes to internal policies or procedures, that should impact
the calculation of LGD but which are not otherwise reflected in the modelling.
6.2.2 Considerations for a simpler approach
It may be possible to use portfolio averages for some components of LGD (e.g. if a
separate value for the component cannot be estimated for each exposure) as
opposed to applying a more granular estimation for all components of LGD. In
other cases, estimation may only be possible based on portfolio-level averages. An
entity determines whether a particular approach is acceptable by considering data
availability and the risk of error, including ensuring information is unbiased (e.g. if
conservative averages were used or if data reflected only good or bad times).

The estimation still considers any macro-economic dependency although the depth
of the analysis carried out may be less.

The data histories used to support the analysis may be shorter or not cover the
full range of variables used in the LGD analysis

While appreciating that the two modelling approaches are not affected by staging,
more specific data is preferred to model the LGD. Key factors should be considered
before adopting a particular model. This is so in appreciation of various loans
issued by the financial institutions, i.e. collateralized and non-collateralized.

ICPAU Implementation Guidance on IFRS 9 Page 34 of 48

 It is however recommended that simpler approach is adopted due to
unavailability of data. The sophisticated approach should be applied where
data is available and risk of error is minimal.
For Noting
Full adoption and implementation is expected as regards;
 Failure to perform analysis
 Failure to make adjustments to comply with regulatory requirements
 Failing to update collateral values when modelling the term structure of LGD.
[IFRS 9.B5.5.55]

7.0 DISCOUNTING
An entity shall measure expected credit losses in a way that reflects the time
value of money. For financial assets, a credit loss is the present value of the
difference between:
a) The contractual cash flows that are due to an entity under the contract; and
b) The cash flows that the entity expects to receive.

IFRS 9 requires expected credit losses (ECL) to be discounted to the reporting date
using the effective interest rate (EIR) determined at initial recognition or an
approximation of it. This is because the original carrying amount of the asset
would have been based on the discounted contractual cash flows, and so not to
discount cash flows that are now not expected to be received would overstate the
loss. If the instrument has a variable interest rate, the ECL should be discounted
using the current EIR.
The table sets out the discount rates to be used for different types of financial
instrument.
Discount rates to be used for different types of financial instrument
Instrument Discount rate to be used
Fixed rate assets  effective interest rate determined at initial
recognition
Variable rate assets  current effective interest rate
Purchased or originated credit impaired  credit-adjusted effective interest rate
financial assets determined at initial recognition
Lease receivables  same discount rate as used in the
measurement of the lease receivable
Loan commitments  effective interest rate, or an approximation
of it, that will be applied when recognising
the financial asset resulting from the loan
commitment
Loan commitments for which the effective  a rate that reflects the current market
interest rate assessment of the time value of money and
cannot be determined the risks specific to the cash flows (unless
adjustment has instead been made to the

ICPAU Implementation Guidance on IFRS 9 Page 35 of 48

 cash shortfalls)
Financial guarantee contracts  a rate that reflects the current market
assessment of the time value of money and
the risks specific to the cash flows (unless
adjustment has instead been made to the
cash shortfalls)
The effect of discounting may be significant because default events and/or
associated cash shortfalls may occur a long time into the future. Although the
determination of the EIR has not changed from IAS 39, focus on its interaction with
the impairment requirements of IFRS 9 is now of great consideration. In
implementation of IFRS 9, an entity needs to consider whether approximations
used in determining EIRs under IAS 39 remain appropriate given the more significant
role that discounting has in measuring impairment under IFRS 9 (e.g. discounting
of cash shortfalls that may occur a number of years into the future).

Likely Challenges
 There may be a challenge in generating original EIR across all or some
portfolios.
 Also, the discount rate used varies across entities. Therefore, entities will have
to come up with ways to adjust their Loss Given Defaults (LGDs) to reflect
the discounting effect required by the standard (i.e., based on a rate that
approximates the original EIR and over the entire period from recoveries back
to the reporting date).

This could be achieved either by extracting the expected undiscounted cash flow
recoveries from the LGD and discounting them back using the appropriate rate
over the entire period, or by directly adjusting the LGD to approximate the correct
calculation. Given the requirement to use an approximation to the EIR, entities
will need to work out how to determine a rate that is sufficiently accurate. One of
the challenges is to interpret how much flexibility is afforded by the term
‘approximation’.

7.1 Suggested Approaches

7.1.1 Sophisticated Approach

ECLs are calculated by estimating the timing of the expected cash shortfalls
(taking into consideration realisation of collateral) associated with defaults and
discounting them.
The discount rate is the EIR. For a financial guarantee contract, the discount rate
reflects the current market assessment of the time value of money and the risks
specific to the cash flows. Discount rates may be based on portfolio averages if this
represents a reasonable approximation of the EIR.

ICPAU Implementation Guidance on IFRS 9 Page 36 of 48

 For variable rate assets, the benchmark interest rate used to calculate the EIR may
be either the current benchmark interest rate or a projected rate based on forward
yield curves.

Assumptions about prepayments, extensions and utilisation during the period of

exposure (and within contractual credit limits) used in the ECL calculation are
updated to reflect currently available information and are consistent with those
used in estimating interest income.

The unwind of the time value of money (as the ECL is recalculated from period-to-
period) is separately tracked, such that appropriate adjustments can be made to
the interest income amount for credit-impaired assets if this is otherwise
calculated on the gross carrying amount of the financial asset.

7.1.2 Considerations for a simpler approach

The time value of money is reflected in ECL calculations using estimated portfolio
average collection periods (provided this is demonstrated to be a reasonable
approximation).

For Noting
The following are not compliant:
 Using the discount rate employed for regulatory purposes in the calculation of
ECL / LGD without making appropriate adjustments or evidencing that the
impact of such adjustments would not be material.
 Continuing to use IAS 39 EIR approximations without assessing whether their use
is appropriate for the purposes of IFRS 9, particularly given the longer time
horizons over which amounts may be discounted under IFRS 9.
 Not reflecting the effect of the time value of money in ECL, or using discount
rates which do not suitably approximate the EIR of the instrument or portfolio
(e.g. current funding rates or risk-free rates).

8.0 MACRO-ECONOMIC FORECASTS AND FORWARD-LOOKING INFORMATION

8.1 Principle

The standard establishes that management should measure expected credit losses
over the remaining life of a financial instrument in a way that reflects:
 an unbiased and probability-weighted amount that is determined by
evaluating a range of possible outcomes;
 the time value of money; and
 reasonable and supportable information about past events, current conditions and
reasonable and supportable forecasts of future events and economic conditions
at the reporting date.

ICPAU Implementation Guidance on IFRS 9 Page 37 of 48

A measure of ECL is an unbiased probability-weighted amount that is determined
by evaluating a range of possible outcomes and using reasonable and supportable
information that is available without undue cost or effort at the reporting date
about past events, current conditions and forecasts of future economic conditions.
[IFRS 9.5.5.17]

The Standard requires expected credit losses to be discounted to the reporting

date using the effective interest rate determined at initial recognition or an
approximation of it.

Reasonable and supportable information is that which is reasonably available

at the reporting date without undue cost or effort, including information
about past events, current conditions and forecasts of future economic
conditions. The information used is required to reflect factors that are specific to
the borrower, general economic conditions and an assessment of both the current
as well as the forecast direction of conditions at the reporting date. Information
that is available for financial reporting purposes is always considered to be available
without undue cost or effort.

When incorporating future information, an entity should consider information from a

variety of sources in order to ensure that the information used is reasonable and
supportable. Further, the information considered can vary depending on the facts
and circumstances, including the level of sophistication of the entity and the
particular features of the portfolio of financial assets.

While IFRS 9.5.5.18 and [IFRS 9.B5.5.42] do not expect an entity to consider every
possible forward-looking economic scenario, the scenarios considered should reflect
a representative sample of possible outcomes. This is noted in [IFRS 9.BC5.265,]
which states that the calculation of an expected value need not be a rigorous
mathematical exercise whereby an entity identifies every single possible outcome
and its probability but, when there are many possible outcomes, an entity may use a
representative sample of the complete distribution for determining the expected
value.

An entity must demonstrate that the forward-looking (as well as past and current)
information selected has a link to the credit risk of particular loans or portfolios.
For a variety of reasons, it may not always be possible to demonstrate a strong link
in formal statistical terms between individual types of information, or even the
information set as a whole, and the credit risk of some exposures or portfolios.
Particularly in such circumstances, a bank’s experienced credit judgment will be
crucial in establishing an appropriate level for the individual or collective
allowance.

ICPAU Implementation Guidance on IFRS 9 Page 38 of 48

 When there is a non-linear relationship between the different forward-looking
scenarios and their associated credit losses, more than one forward-looking scenario
would need to be incorporated into the measurement of expected credit losses to
meet the above objective. Macroeconomic forecasts and other relevant information
should be applied consistently across portfolios, where the credit risk drivers of the
portfolios are affected by these forecasts/assumptions in the same way.
8.1.1 Possible data sources may include:

 internal historical credit loss experience

 internal ratings
 credit loss experience of other entities
 external ratings, reports and statistics.
Where an entity does not have sufficient sources of entity-specific data of its own,
it may use peer group experience for comparable financial instruments.

8.1.2 Challenges

 Entities are required to evaluate the impact of forward-looking economic changes

on their expected credit losses under a range of unbiased possible economic
outcomes. Their process is required to consider both possibilities: that credit
loss occurs, or not. Many entities have difficulty in developing credible economic
scenarios to measure expected credit losses that reflect an unbiased,
probability-weighted outcome.
 Availability and relevance of forward looking (macro-economic) data points in
the Ugandan Market. To find accurate forward looking factors, entities may rely
on historical information to identify correlations between different (macro-
economic) factors and eventual credit losses. These factors are then mapped
and monitored going forward.

8.2 Suggested approach

The overall approach to calculating ECL involves either to:

 Take the weighted average of the credit loss determined for each of the multiple
scenarios selected, weighted by the likelihood of occurrence of each scenario
plus/minus a separate adjustment for ‘additional’ factors; or
 Take the credit loss determined for the base scenario plus/minus a separate
modelled adjustment to reflect the impact of other less likely scenarios and the
resulting non-linear impacts (as a proxy for the above method) plus/minus a
separate adjustment for ‘additional’ factors.

Additional factors are alternative economic scenarios or events not taken into
account in the scenarios used in the main calculation (e.g. more extreme or
idiosyncratic events not otherwise reflected in historical or forecast information
such as impact of elections or terrorist attack).

ICPAU Implementation Guidance on IFRS 9 Page 39 of 48

The following principles are applied within the approach adopted:

 Number of economic scenarios: Representative scenarios that capture material

non-linearities are modelled (e.g. a base scenario, an upside scenario and a
downside scenario). Different numbers of scenarios may be appropriate
depending on the facts and circumstances - e.g. in periods of expected increased
volatility. [IFRS 9.BC5.265]

 Determining alternative economic scenarios: Scenarios may be internally

developed or, for less sophisticated entities like banks, may be vendor-defined.
For internally developed scenarios, an entity should have a variety of experts,
such as risk experts, economists, business managers and senior management,
assist in the selection of scenarios that are relevant to the entity`s credit risk
exposure profile. When developing and using internal forecasts, an entity
considers third party data and views and justifies differences from external
forecasts, but this does not mean it must replicate them. For vendor-defined
scenarios, a bank should ensure that the vendor tailors the scenarios to reflect
its own business and credit risk exposure profile, as the bank remains
responsible for those scenarios.

 Representative scenarios: upside and downside scenarios used are not biased to
extreme scenarios such that the range and weighting of scenarios used is not
representative.

 Base scenario: the base scenario is consistent with relevant inputs to other
estimates in the financial statements (e.g. deferred tax recoverability and
goodwill impairment assessments), budgets, strategic and capital plans, and
other information used in managing and reporting by the bank. However, these
inputs should not be lagging or biased.

 Sensitivities and asymmetries: scenarios selected are representative and take

account of key drivers of ECL, particularly non-linear and asymmetric
sensitivities within portfolios. The sensitivity of ECL to each individual forward
economic parameter is monitored to identify key drivers and to estimate effects
of changes in parameters on ECL.

 Parameter coherence: in developing the detail of a specific economic scenario

(e.g. a scenario with individual point estimates of future GDP, unemployment,
interest rates, etc.), any expected correlation or other interrelationship
between parameters (e.g. an increase in unemployment is expected to result in
a decrease in interest rates) is considered in the development of the scenario so
that it is realistic.

ICPAU Implementation Guidance on IFRS 9 Page 40 of 48

8.2.1 Considerations for a simpler approach
The level of detail used in addressing each principle may be proportionately less
for a simpler approach. A bank may be able to perform a simpler analysis of
historical relationships between observed defaults / credit losses and the overall
position within the economic cycle at the time, which can then be used to estimate
ECLs at different future estimated points in the economic cycle.

Where a bank does not have its own data to do this, it makes use of available
external data sources such as industry data. This approach would involve three
steps firstly obtaining historical macroeconomic variables, determine the
macroeconomic variables that affect impairment parameters and lastly obtain or
project future macroeconomic variables under various scenarios and assign
probability to them.

8.2.2 Data sources

One of the challenges identified availability and relevance of forward looking
(macroeconomic) data points in the Ugandan Market. The following table
illustrates data sources that may be used for macroeconomic information.
Data source Type of data
Local established agencies such as GDP, Industry performance , demographics,
Uganda National Bureau of statistics Inflation , credit spreads, interest rates,
and Central Bank of Uganda exchange rates, bond yields, real estate prices,
national debt repayment capacity etc.
International rating agencies such Country ratings, forecast macroeconomic
as: information.
Moody and Standard & Poor, World
Bank, IMF, World Economic Forum
Financial data vendors terminal GDP, Industry performance , demographics,
such as: Inflation , interest rates, exchange rates etc.
Bloomberg, Thomson Reuters, BMI
Research

For Noting
 Considering only a single future economic scenario for a portfolio with no
separate adjustments to take account of non-linear impacts, unless the portfolio
has no potentially material asymmetric exposures to ECL and this is evidenced
by appropriate analysis. [IFRS 9.5.5.17, B5.5.42, BC5.263].
 Forecasts that are only developed internally or that only reference a single
external source. Although a bank does not need to consult all available sources,
it should consider information from a variety of sources and understand whether
it supports or contradicts the bank’s own forecasts of the future, in order to
ensure that the information used is reasonable and supportable. [IFRS 9.5.5.17,
B5.5.51].

ICPAU Implementation Guidance on IFRS 9 Page 41 of 48

9.0 IFRS 9 - ORGANISATION IMPLEMENTATION PLAN
9.1 IFRS 9 and Cross Functional Governance
With the emergence of IFRS 9 and the antecedent requirement for an entity to
make appropriate provisions in anticipation of future potential losses, rather than
the current practice of providing only when losses are incurred, there are far
reaching implications as this should likely hike the provisioning and hence hurting
the earnings and exert pressure on the capital resources of an entity particularly
for Banks. Early simulation indicted that under the banking industry, provisions
computed under IFRS 9 were Ush. 221.5 billion higher than the required provisions
under the Financial Institutions Act. This was a preliminary result with expectation
of the figure increasing in the full assessment of the Banks’ performance for the
year.
9.2 IFRS 9 and Organisation Strategy

As a result in trying to deal with the potentially higher provisioning, an entity, for
example a bank will likely need to revise their business strategy by for example
thinking twice about extending certain types of loan facilities if they are deemed
risky or no longer profitable, reduce the limit of undrawn facilities like overdrafts
IFRS 9 also introduces a three stage model for provisioning based on changes in
credit quality since the loan was extended. In a typical banking setup, stage 1
loans would be considered the performing loan account with stage 2 and 3 as the
underperforming and non performing accounts respectively. Since for facilities that
fall under stage 1, the Bank will have to provide for 12 months forward looking
expected credit losses, for stage 2 and 3, the Bank will have to provide lifetime
ECL. The implication of this provisioning on the Banks’ strategy and approach to
business is that, the Banks will need to choose the clientele a little carefully
between individuals and corporate or even SMEs. The expected maturity of the
loan facility will also matter, since mortgage loan with an expected maturity of 20
years will carry a different provisioning from a mortgage facility of 50 years. The
Banks’ collection Department would now be put on notice as it would play a key
role in avoid facilities move from stage 1 to stage 2 ot 3 with heavier provisioning.
Transition from stage 1 to stage 2 would also require the Bank’s legal team to for
example advise whether based on the running contract between the Bank and the
borrower, there is a possibility for the Bank to ask for additional interest or
collateral to minimise the extent of default.
9.3 IFRS 9 and an entity’s Internal Processes and Controls

Unlike with IAS 39, IFRS 9 requires provisioning for unutilised lines of credit for
example overdraft limits and Bank guarantees, which are all off the balance sheet
items. Banks will equally provide for Uganda Government debt instruments such as
treasury bills and bonds that they invest in as well as all lending to Bank of
Uganda. Bank of Uganda in its December 2018 circular to all supervised financial

ICPAU Implementation Guidance on IFRS 9 Page 42 of 48

 institutions requires banks to classify the securities as low credit risk and not
subject such securities to an assessment of significant increase in credit risk. The
impact arising out of the above analysis is the role that the treasury department
will have to play in managing these investments between the stages.
9.4 IFRS 9 and the Board of Directors

Making sure that the bank has effective controls over compliance with the new
financial reporting requirements – and guarding against the reputational,
regulatory and financial damage that may result from material control failures –
will be key concerns for those charged with governance (GPPC, 2016)
A bank’s board of directors and senior management are responsible for ensuring
that the bank has appropriate credit risk practices, including an effective system
of internal control, to determine adequate expected credit loss (ECL) allowances
in accordance with IFRS 9 as well as the bank’s stated policies and relevant
supervisory guidance.
The key concerns for those charged with governance would include:
(a) Who develops and ensures compliance with accounting and risk policy?
(b) Is there appropriate governance and control to ensure transparency between
accounting interpretations and risk interpretations?
(c) What existing governance framework is there over model design, development
and maintenance?
(d) Is there an existing forum to challenge, review and approve impairment?
(e) What is the policy and who has responsibility for approving
adjustments/overlays made to the impairment figures and models?
(f) Who is responsible for the business model review? Is there
input/guidance/review from finance?
BOU, 2018, requires Banks’ Board of Directors to put in place adequate and robust
policies and procedures, information technology systems, internal control process
and also devote sufficient financial and human resources for IFRS 9
implementation. The governance structure must be aligned to the risk management
framework, appropriately reflect the size and complexity of the institutions and
must be reviewed annually.
Therefore as a basic minimum, there is need for early involvement with auditors
and interaction with regulators on key decisions, frequent interaction with senior
governance forums, such as the Board of Directors and Audit Committee and clear
Governance protocols, including clear decision-making criteria, within project
steering committees and other governance forums. BOU, 2018 requires Banks to
constitute an IFRS 9 implementation project steering committee.

ICPAU Implementation Guidance on IFRS 9 Page 43 of 48

9.5 Human Resources and IFRS 9 Implementation

IFRS 9 introduces new roles and skill set required for effective implementation. An
entity is required to build capacity for its human resources particularly in credit
risk modelling, model validation, statistical analysis among others. Where an entity
may not have the requisite skill set among its staff, it may consider engaging
external consultants to provide the required technical support. However, such an
entity should establish a clear framework to enable knowledge transfer to the
entity’s staff.
10.0 IMPACT OF TRANSITION WITHIN THE BANKING SECTOR

The Basel Committee on Banking Supervision (BCBS) published guidance 5 in

December 2015 on credit risk and accounting for expected credit losses. 6 The
guidance sets out supervisory expectations for banks relating to sound credit risk
practices associated with implementing an expected credit loss framework. It also
highlights three IFRS 9-specific requirements banks should consider when designing
and operationalizing their implementation plan. With respect to defining and
measuring significant deterioration in credit risk, the BCBS is of the view that
delinquency data should only be used in rare circumstances and lifetime expected
credit losses are generally anticipated to be recognized before a missed payment
occurs.

BCBS guidance provides that banks should “have processes in place that enable them
to determine [significant credit risk] on a timely and holistic basis so that an individual
exposure, or a group of exposures with similar credit risk characteristics, is
transferred to [lifetime expected credit losses] measurement as soon as credit risk
has increased significantly, in accordance with the IFRS 9 impairment accounting
requirements.”7

The BCBS guidance also recommends that banks establish policies and specific criteria
for what constitutes a “significant” increase in credit risk for different types of
lending exposures.

As a practical expedient, IFRS 9 provides an exception for low credit risk exposures,
where “entities have the option not to assess whether credit risk has increased
significantly since initial recognition. [The low credit risk exemption]

5 Basel Committee on Banking Supervision, Guidance on credit risk and accounting for expected credit losses,”

Bank for International Settlements, December 2015. http://www.bis.org/bcbs/ publ/d350.pdf .

6 The purpose of this document is to provide supervisory guidance on accounting for expected credit losses

that does not contradict with accounting guidance

7Basel Committee on Banking Supervision, Guidance on credit risk and accounting for expected credit losses,”
Paragraph A16.

ICPAU Implementation Guidance on IFRS 9 Page 44 of 48

was included to reduce operational costs.” 8 However, it is the BCBS’s expectation
“that use of this exemption should be limited.” In addition, the BCBS expects
banks to assess significant increases in credit risk for all lending exposures in a
timely manner.

8 Basel Committee on Banking Supervision, Guidance on credit risk and accounting for expected credit losses,”

Paragraph A48.

ICPAU Implementation Guidance on IFRS 9 Page 45 of 48

APPENDIX: ILLUSTRATIVE CALCULATIONS FOR ECL
Example 1: Lifetime ECL for Trade Receivables Using a Provision Matrix
XYZ Limited is a company that deals in installation and maintenance of accounting
software. The company usually transacts with its customers on credit, therefore, it
has a significant balance of trade receivables outstanding at each reporting date. XYZ
Limited recognises lifetime ECL for all its trade receivables since there is no significant
financing component on them.
i) Using the information provided in the table below, the loss rate of XYZ will be as
indicated.
Details Payments Receivables Receivables ageing Loss Rate
outstanding

Sales at 1/1/20X9 500,000 Not overdue 2%

Cleared on time 250,000 250,000 overdue 1-30 days 4%
paid 1-30 days after due 120,000 130,000 overdue 31-60 days 8%
date

paid 31-60 days after 80,000 50,000 overdue 61-90 days 20%
due date

paid 61-90 days after 40,000 10,000 overdue 91+ days 100%
due date
(not paid at all)

Note:
 For the purpose of this example, the loss rate is calculated based on sales made
as at 1/1/20X9. In real life, however, the loss rate computation should be based
on data from several months, but it should not be too old as this would yield to
outdated results.
 Additionally, we assume that XYZ Limited analysed forward-looking information
(GDP forecasts, changes in unemployment rate, inflation) and concluded that
there is no indication that the above historical loss rate should be adjusted (see
IFRS 9.B5.5.52-53).
 Loss rate = (amount unpaid/receivables outstanding for the month)*100%

ii) XYZ Limited prepared an ageing of its receivables as at 31/12/20X9 as seen below.
Trade receivables 700,000 400,000 180,000 110,000 70,000
Ageing not overdue overdue overdue Overdue
overdue 1-30 days 31-60 days 61-90 days 91+ days

Using the loss rates obtained in (i) above, XYZ Limited’s lifetime ECL will be as
follows.

ICPAU Implementation Guidance on IFRS 9 Page 46 of 48

 ECL = loss rate X trade receivables amount
Trade receivables Ageing Loss rate ECL allowance
700,000 Not overdue 2.0%
14,000

400,000 overdue 1-30 days 4.0%

16,000

180,000 overdue 31-60 days 7.7%

13,860

110,000 overdue 61-90 days 20.0%

22,000

70,000 overdue 91+ days (not 100.0%

paid at all) 70,000

Total ECL Allowance 135,860

Therefore, the total ECL allowance for XYZ Limited as at 31/12/20X9 will be
135,860/-

Example 2: Illustrative calculation of lifetime ECL and 12-month ECL for a loan
Money House Limited is an established banking institution in Uganda with a financial
year ending 30 June. On 30 June 20X4, Money House Limited lent Shs.10 million to
Kaka & Co repayable over 5 years at a rate of 25% p.a, compounded. Money House
Limited’s Finance Manager has informed you that the probability of default (PD) in the
first three years will be 3% and 4% in the last two years.
Calculation of both 12-month ECL and lifetime ECL is based on the following:
PD – probability of default (which should be assessed by the lender, who in this case
is, Money House Limited)
EAD – exposure at default (which is equal to the amortised cost of the loan)
LGD – loss given default (i.e. what percentage of EAD will not be recovered at
default). For purposes of this example, let us assume that LGD=70%
Step 1: Determine the expected annual cash flows over the loan repayment period.
Financial year end Expected annual cash flows
30/06/20X4 (10,000,000)
30/06/20X5 2,500,000
30/06/20X6 2,500,000
30/06/20X7 2,500,000
30/06/20X8 2,500,000

ICPAU Implementation Guidance on IFRS 9 Page 47 of 48

 30/06/20X9 2,500,000

Step 2: Determine the effective interest rate (EIR)

This will be calculated using the formula below:
EIR = ((1 + (1/n)) ^n)-1
Where n = number of compounding periods
EIR= 7.9%

Step 3: amortise the cash flows receivable

year opening balance 1 Jan interest in P/L cash flow closing balance 31 Dec
2004 10,000,000 792,801 (2,500,000) 8,292,801
2005 8,292,801 657,455 (2,500,000) 6,450,256
2006 6,450,256 511,377 (2,500,000) 4,461,633
2007 4,461,633 354,726 (2,500,000) 2,316,359
2008 2,316,359 183,641 (2,500,000) 0

Step 4: Determine ECL

Reporting Date EAD PD (marginal) PD (cumulative) LGD EIR Marginal ECL

30/06/2004 10,000,000 3% 3% 70% 7.9% 194,574
30/06/2005 8,292,801 3% 6% 70% 7.9% 149,504
30/06/2006 6,450,256 3% 9% 70% 7.9% 107,744
30/06/2007 4,461,633 4% 13% 70% 7.9% 92,069
30/06/2008 2,316,359 4% 17% 70% 7.9% 44,289

12-month ECL (ECL12M) = PD12M X LGD12M X EAD12M X D12M

ECL12M = Shs. 194,574

Lifetime ECL (ECLLT) = ∑ (PDt X LGDt X EADt X Dt)

ECLLT = 194,574 + 149,504 + 107,744 + 92,069 + 44,289
ECLLT = Shs. 588,180

ICPAU Implementation Guidance on IFRS 9 Page 48 of 48