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Consider the following statements regarding the Expected Credit Loss (ECL) Framework in loan-loss provisioning:
- Under this, a bank is required to estimate expected credit losses based on forward-looking estimations before making corresponding loss provisions.
- It will result in a shortfall of provisions as compared to excess provisions.
Which of the statements given above is/are correct?
- a)1 only
- b)2 only
- c)Both 1 and 2
- d)Neither 1 nor 2
Correct answer is option 'A'. Can you explain this answer?
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Most Upvoted Answer
Consider the following statements regarding the Expected Credit Loss (...
Explanation:
The Expected Credit Loss (ECL) Framework is a provision introduced by the International Financial Reporting Standard (IFRS) 9. It requires banks and other financial institutions to estimate expected credit losses on their financial assets, such as loans and receivables, based on forward-looking estimations before making corresponding loss provisions.
Statement 1: Under this, a bank is required to estimate expected credit losses based on forward-looking estimations before making corresponding loss provisions.
This statement is correct. The ECL Framework requires banks to estimate the expected credit losses on their financial assets, such as loans, based on forward-looking estimations. This means that banks need to consider all available information, including historical data and future economic conditions, to assess the potential credit losses on their loans. By doing so, banks can make more accurate provisions for expected credit losses and reflect them in their financial statements.
Statement 2: It will result in a shortfall of provisions as compared to excess provisions.
This statement is incorrect. The ECL Framework aims to ensure that banks have appropriate provisions for expected credit losses. It does not necessarily lead to a shortfall or excess of provisions. Instead, it requires banks to make provisions that reflect the expected credit losses based on forward-looking estimations. This means that banks need to account for potential credit losses in a timely manner and ensure that their provisions are adequate to cover these losses.
The ECL Framework helps banks to be more proactive in managing credit risk and ensures that their provisions are more accurately aligned with the potential credit losses. It provides a more forward-looking approach to loan-loss provisioning, which enhances the transparency and reliability of financial statements. By estimating expected credit losses and making corresponding provisions, banks can better assess their credit risk exposure and make informed decisions regarding their lending activities.
In conclusion, the correct answer is option A, as statement 1 is correct but statement 2 is incorrect.
The Expected Credit Loss (ECL) Framework is a provision introduced by the International Financial Reporting Standard (IFRS) 9. It requires banks and other financial institutions to estimate expected credit losses on their financial assets, such as loans and receivables, based on forward-looking estimations before making corresponding loss provisions.
Statement 1: Under this, a bank is required to estimate expected credit losses based on forward-looking estimations before making corresponding loss provisions.
This statement is correct. The ECL Framework requires banks to estimate the expected credit losses on their financial assets, such as loans, based on forward-looking estimations. This means that banks need to consider all available information, including historical data and future economic conditions, to assess the potential credit losses on their loans. By doing so, banks can make more accurate provisions for expected credit losses and reflect them in their financial statements.
Statement 2: It will result in a shortfall of provisions as compared to excess provisions.
This statement is incorrect. The ECL Framework aims to ensure that banks have appropriate provisions for expected credit losses. It does not necessarily lead to a shortfall or excess of provisions. Instead, it requires banks to make provisions that reflect the expected credit losses based on forward-looking estimations. This means that banks need to account for potential credit losses in a timely manner and ensure that their provisions are adequate to cover these losses.
The ECL Framework helps banks to be more proactive in managing credit risk and ensures that their provisions are more accurately aligned with the potential credit losses. It provides a more forward-looking approach to loan-loss provisioning, which enhances the transparency and reliability of financial statements. By estimating expected credit losses and making corresponding provisions, banks can better assess their credit risk exposure and make informed decisions regarding their lending activities.
In conclusion, the correct answer is option A, as statement 1 is correct but statement 2 is incorrect.
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Community Answer
Consider the following statements regarding the Expected Credit Loss (...
Private sector lender ICICI Bank recently said the bank is ready to move to an expected credit loss (ECL) framework for provisioning.
What is the Expected Credit Loss (ECL) regime?
- Under this practice, a bank is required to estimate expected credit losses based on forward-looking estimations rather than wait for credit losses to be actually incurred before making corresponding loss provisions.
- As per the proposed framework, banks will need to classify financial assets (primarily loans) as Stage 1, 2, or 3, depending on their credit risk profile, with Stage 2 and 3 loans having higher provisions based on the historical credit loss patterns observed by banks.
- Thus, through ECL, banks can estimate the forward-looking probability of default for each loan, and then by multiplying that probability by the likely loss given default, the bank gets the percentage loss that is expected to occur if the borrower defaults.
- This will be in contrast to the existing approach of incurred loss provisioning, whereby step-up provisions are made based on the time the account has remained in the Non-Performing Asser (NPA) category.
- Benefits of the ECL regime:
- It will result in excess provisions as compared to a shortfall in provisions, as seen in the incurred loss approach.
- It will further enhance the resilience of the banking system in line with globally accepted norms.
What is the problem with the incurred loss-based approach?
- It requires banks to provide for losses that have already occurred or been incurred.
- The delay in recognizing loan losses resulted in banks having to make higher levels of provisions which affected the bank's capital. This affected banks’ resilience and posed systemic risks.
- The delays in recognizing loan losses overstated the income generated by the banks, which, coupled with dividend payouts, impacted their capital base.
Hence only statement 1 is correct.
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Consider the following statements regarding the Expected Credit Loss (ECL) Framework in loan-loss provisioning: Under this, abank is required to estimate expected credit losses based on forward-looking estimationsbefore making corresponding loss provisions. It willresult in a shortfall of provisionsas compared to excess provisions.Which of the statements given above is/are correct?a)1 onlyb)2 onlyc)Both 1 and 2d)Neither 1 nor 2Correct answer is option 'A'. Can you explain this answer?
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