Transition-Based Expected Credit Losses Calculation under CECL/IFRS 9

Abstract

The new accounting standards, namely, IFRS 9 and CECL, require calculating the expected credit losses (ECL). In this article, we focus on the ECL calculation within the transition-based framework for retail lending products, including residential mortgages, home equity lines of credit (HELOCs), and credit cards. Given the estimated parameters, the ECL calculation for credit cards is exact, whereas the ECL calculations for mortgages and HELOCs are approximate. Particularly, we proposed an upper bound and a lower bound for mortgage ECL under mild assumptions, whereby their approximation errors are typically less than 2% and 0.2%, respectively. Moreover, compared to the path-dependent tree method, the upper and lower bounds can be computed much faster, making them practical candidates for ECL calculations on a long horizon.

Keywords: IFRS 9, CECL, Expected Credit Losses, Credit Risk, Retail Credit

JEL Classification: C41, G21, G32, M48