Collections can influence severity of loss

Traditionally, the relationship between collections and impairment is one way under IAS39. Collections activity can influence the severity of the loss and in the best case, can return accounts to order. This impacts the impairment line in two ways, the amount recovered and the direct cost of collecting it.

The reason for this very one directional relationship is the way in which impairment is calculated currently under IAS39. It is estimated based on incurred loss, so a binary trigger event has to occur before a loss is recognised in the P&L, these binary events typically occur as a result of financial difficulty and manifest themselves as missed payments (delinquency) or help with payment schedules.

Often, once these states are no longer applicable and the customer is back to paying their regular schedule, and are up to date, these assets are treated as performing and only a small amount of provision is held. This has no ongoing impact on the provision of that asset.

Under IFRS9, these binary measures are only used as back stops, either for entry to Stage 2 or entry to Stage 3 but critically a ‘cure’ period is expected, similar to that used in IRB (Internal Ratings Based-approach) to indicate when an asset has not only got back up to date but is also not likely to re-default in the near future.

How this is assessed is still up for debate but it does extend the period for being treated as Stage 3, even if the account is up to date; for example if interest has been reduced or frozen on a credit card.