NFRS 9: Impairment Models

A practical guide to calculating Expected Credit Losses (ECL) using the Provision Matrix for trade receivables and the general EAD x LGD x PD model.

1. Simplified Approach: Provision Matrix for Trade Receivables

For non-complex instruments like trade receivables, NFRS 9 allows a simplified approach using a provision matrix to estimate Expected Credit Losses (ECL).

This method involves categorizing receivables based on their aging (how overdue they are) and applying a historical or forward-looking loss rate to each category. This approach must be based on historical data, current conditions, and reasonable future forecasts.

Example: Building a Provision Matrix

This is a demonstrative example. Please do not use for actual Scenarios.

Using Central Bank’s Provision as a Baseline

Pass Loans	1%	upto 30 Days
Watchlist Loans	5%	upto 3 Months
Substandard Loans	25%	upto 6 Months
Doubtful Loans	50%	Upto 12 Months
Loss Loans	100%	After 12 Months

The respective rates are then multiplied with an adjusting factor.

Where adjusting factor = Original Rate / k * Original Rate^p

Where, k is a scaling factor and p is a power to control adjustment intensity.

Example Calculation

K is calculated as: The Total Asset of Largest Commercial Bank for which the bank’s Provision Apply / Total Asset of The concerned Entity. Let’s just Assume, the value is 10.

P (Adjustment Intensity) is calculated as: Total Asset of the Concerned Entity / Total Asset of Lowest class of Financial Institutions for which the Provisions Applies. Let’s Assume that as 0.08.

The Adjusted rates come as:

Classification	Allowance Rate
Prime Receivables	0.05%
Standard Receivables	0.26%
Watchlist receivables	1.49%
Concern receivables	3.15%
Doubtful receivables	6.67%

Write off any receivables that have been concluded as being Non-Receivables.

Allowance Calculation

Current	Prime Receivables	Standard Receivables	Watchlist receivables	Concern receivables	Doubtful receivables
Allowance rate	0.05%	0.26%	1.49%	3.15%	6.67%
Portfolio of Receivables	22,500,000.00	14,500,000.00	2,500,000.00	3,500,000.00	7,000,000.00
Allowance Amount	10,273.47	37,784.96	37,179.82	110,206.20	466,666.67

Again, This is just an Example, Please don’t try to use it.

2. General Approach: EAD x LGD x PD

For more complex financial assets like loan portfolios, the general approach involves calculating ECL as the product of three key components.

EAD x LGD x PD

Exposure at Default x Loss Given Default x Probability of Default

A. Exposure at Default (EAD)

This is the total value a company is exposed to when a debtor defaults. For loans, it's typically the outstanding principal and accrued interest at the time of default.

For our example, we'll use a total loan portfolio with an EAD of 51,133,800.

B. Loss Given Default (LGD)

This is the portion of the EAD that is expected to be lost if a default occurs. It's calculated after considering any collateral, guarantees, or other credit enhancements.

LGD = EAD - (Recoveries from Collateral + Recoveries from Guarantees/Insurance)

Example LGD Calculation:

Loan Portfolio	EAD	FV of Collateral	Insurance Coverage	Loss Given Default
Portfolio A	5,225,000	3,396,250	261,250	1,567,500
Portfolio B	9,856,000	8,574,720	492,800	788,480
...	...	...	...	...
Total Loss Given Default for Portfolio				6,404,018

C. Probability of Default (PD)

This is the likelihood that a borrower will default over a specific time horizon (e.g., 12 months for Stage 1 assets, lifetime for Stage 2/3). This is often the most complex part, derived from historical data, macroeconomic models, and credit rating transitions.

Example PD Rates (illustrative):

Risk Category / Stage	12-Month PD
Good Loans (Stage 1)	3.45%
Sub-Standard (Stage 2)	8.90%
Risky Loans (Stage 3)	34.04%
Loss Loans (Stage 3)	100.00%

Putting It All Together: Final ECL Calculation

Risk Category	EAD	LGD % (LGD/EAD)	PD	ECL (EAD x LGD% x PD)
Good Loans	155,083,844	12.5%	3.45%	669,459
Sub-Standard	69,038,883	12.5%	8.90%	768,435
Risky Loans	18,673,321	12.5%	34.04%	794,547
Loss Loans	7,203,952	12.5%	100.00%	900,494
Total Impairment Loss to Recognize				3,132,935

Note: LGD % is simplified here for calculation. In practice, LGD would be calculated for each specific asset or sub-portfolio.