The boards discussed a 'three-bucket' expected loss approach for the impairment of financial assets.
The guiding principle of the 'three-bucket' approach is to reflect the general pattern of deterioration of credit quality of loans. Allowance balances would be established for all financial assets subject to impairment accounting. The different phases of the deterioration in credit quality are captured through the 'three-buckets' that determine the allowance balance. Generally, the 'three-bucket' approach would encompass the following:
- Bucket 1: in the context of portfolios, assets evaluated collectively for impairment that do not meet the criteria of Buckets 2 or 3 (this would include loans that have suffered changes in credit loss expectations as a result of macroeconomic events that are not particular to either a group of loans or specific loan).
- Bucket 2: Assets affected by the occurrence of events that indicate a direct relationship to possible future defaults, although the specific assets in danger of default have not yet been identified.
- Bucket 3: Assets for which information is available that specifically identifies that credit losses are expected to, or have, occurred on individual assets.
The boards decided to continue to develop the 'three-bucket' approach. In addition, the boards agreed with the broad approach to distinguish between the buckets on the basis of credit risk deterioration. The boards decided that the allowance balance of Buckets 2 and 3 should be the remaining lifetime expected loss estimate.
The boards provided the following direction to the staff for future deliberations:
- Pursue an approach for Bucket 1 with an overall objective of recognising an impairment allowance equal to losses expected to occur in the next twelve months based on initial expectations plus the full amount of any changes in expected credit losses. However, the boards also noted the operational complexities of such a model, and directed the staff to consider how to operationalise the approach.
- The boards noted the importance of having clear and well-defined indicators and guidance related to when to transfer assets between Buckets 1, 2, and 3. Consequently, they instructed the staff to further develop criteria to determine to which of the three buckets the financial assets should be attributed.