CFM INDOSUEZ Wealth Management - 2019 annual report

C redit risk and impairment/provisioning stages Credit risk is defined as the risk of loss arising from the default of a counterparty resulting in its inability to meet its commitments to the Group. The credit risk provisioning process follows a three stage model (the three bucket model): • 1st stage (Bucket 1): upon initial recognition of the financial instrument (loan, debt security, guarantee, etc.), the entity recognises the expected credit losses over 12 months; • 2nd stage (Bucket 2): if the credit quality of a given transaction or portfolio deteriorates significantly, the entity recognises lifetime expected credit losses; • 3rd stage (Bucket 3): when one or more default events involving the transaction or counterparty occur and adversely affect estimated future cash flows, the entity recognises a lifetime credit loss. Subsequently, if the conditions for classifying financial instruments in Bucket 3 are no longer met, the financial instruments are reclassified to Bucket 2 and then Bucket 1 according to subsequent improvements in the quality of the credit risk. Definition of default The definition of default for the purposes of expected loss provisioning is identical to that used in management and for regulatory ratio calculations. Thus, a borrower is considered to have defaulted when at least one of the following two conditions is met: • where payments are past due by more than ninety days, unless special circumstances show that the arrears are due to events unrelated to the debtor’s situation; • if the entity considers it unlikely that the debtor will fully settle its credit obligations without it having to apply measures such as the enforcement of a security. A loan is deemed to be impaired (Bucket 3) when one or more events having an adverse effect on estimated future cash flows from the financial asset have occurred. Indications of impairment of a financial asset include observable data regarding the following: • significant financial difficulties for the issuer or borrower; • a breach of contract, such as a default or overdue payment; • the granting by the lender(s) to the borrower, for economic or contractual reasons related to the borrower’s financial difficulties, of one or more favours that the lender(s) would not have considered in other circumstances; • an increasing probability of bankruptcy or financial restructuring of the borrower; • the disappearance of an active market for the financial asset due to financial difficulties; • the purchase or creation of a financial asset with a large discount, reflecting the credit losses incurred. It is not necessarily possible to isolate a particular event, as the impairment of the financial asset may result from the combined effect of several events. The defaulting counterparty will only return to a sound situation after it fully settles late payments and the other elements that caused the default are resolved (lifting of the default for the parent company, removal of an alert which caused the default, etc.). The notion of expected credit loss (ECL) The ECL is the present value of probability-weighted estimated credit losses (principal and interest). It is the present value of the difference between contractual cash flows and expected cash flows (including principal and interest). The ECL approach aims to recognise expected credit losses as soon as possible. Governance and measurement of ECL The governance of the IFRS 9 measurement system is based on the organisation set up under the Basel framework. Crédit Agricole Group’s Risk department is responsible for defining the methodological framework and overseeing the provisioning system. The Group relies primarily on the internal rating system and the current Basel processes to generate the IFRS 9 risk parameters needed to calculate expected credit losses. The assessment of changes in credit risk is based on a model that anticipates losses, and extrapolation on the basis of reasonable scenarios. All available, relevant, reasonable and justifiable information, including forward looking information, is used. The calculation formula incorporates probability of default (PD), loss given default (LGD) and exposure at default (EAD) parameters. These calculations are largely based on internal models used for prudential monitoring, where they exist, with adjustments to calculate an economic ECL. IFRS 9 recommends a point in time analysis at the end of the reporting period while taking into account historical loss data and forward looking macro-economic data, while the prudential view is analysed through the cycle for the probability of default and at downturn for the loss given default. The accounting approach also involves recalculating certain Basel parameters, in particular to neutralise internal collection costs or floors imposed by the regulatory authorities for regulatory loss given default calculations. The methods for calculating expected credit losses are to be assessed according to the types of products: financial instruments and off-balance sheet instruments. The 12-month expected credit loss is a portion of lifetime expected credit losses, representing the lifetime cash flow shortfall occurring from a default within 12 months of the reporting date (or a shorter period if the financial instrument’s expected life is shorter than 12 months), weighted by the probability of default. The IFRS 9 parameters are measured and updated according to the methodologies defined by the Group and are used to establish an initial level of reference, or shared base, for provisioning. ECL calculations take into account assets pledged as collateral and other credit enhancements that form an integral part of the instrument’s contractual conditions and that the entity does not recognise separately. The estimate of expected cash flow shortfalls on a financial instrument reflects the amount and schedule for enforcing rights to collateral. In accordance with IFRS 9, the recognition of guarantees and collateral does not influence the assessment of a material increase in credit risk, which depends on changes in credit risk relating to the debtor without taking into account such guarantees. Forward-looking macro-economic data are taken into account in a methodological framework applicable at two levels: • at the level of the Crédit Agricole Group, in determining a shared framework for taking into account forward looking data in the projection of PD and LGD parameters over the transaction amortisation period; • at the level of each entity with respect to its own portfolios. 63 Annual Financial Statements 2019