Revolving facilities and undrawn limits: ECL beyond the contractual period

Credit cards and SME revolving lines can usually be cancelled by the lender at short notice, yet in practice the lender does not cancel them until the customer is already in trouble, by which time more of the limit has been drawn. IFRS 9 therefore requires ECL on such facilities to be measured over the period the lender is actually exposed, which can be years, not the one-day or one-month contractual notice period, and to include expected future drawdowns. Using the contractual period or ignoring undrawn limits can understate ECL substantially, especially in Stage 2, and splitting the allowance incorrectly misstates the provision presented as a liability.

Do the facilities include both a drawn balance and an undrawn commitment, and can the lender cancel or reduce the limit at short notice? In practice, does the lender cancel or reduce limits before default, and how quickly? What behavioural life is supported by data: how long do accounts typically remain open, and how long before default does credit risk management act? Are credit conversion factors estimated from observed drawdown before default, by product and stage? Are SME revolving lines managed collectively like cards, or individually reviewed with a real ability to withdraw at each annual review? Can ECL on the undrawn part be identified separately from ECL on the drawn balance?

1. Identify facilities that include both a loan and an undrawn commitment component where the contractual ability to demand repayment and cancel the undrawn commitment does not limit the lender's exposure to the contractual notice period; these are typically credit cards, overdrafts and some SME revolving lines managed on a collective basis.
2. For these facilities, measure ECL over the period the lender is expected to be exposed to credit risk, which is not limited by the contractual notice period and is reduced only by credit risk management actions the lender expects to take.
3. For Stage 1, this means 12-month ECL measured over 12 months even if the facility can be cancelled tomorrow; for Stage 2 and 3, lifetime ECL over the behavioural life.
4. Estimate exposure at default as the drawn balance plus expected further drawdowns, using credit conversion factors applied to the undrawn limit.
5. Allocate the ECL between the drawn balance (loss allowance deducted from the asset) and the undrawn commitment (provision presented as a liability).
6. Where the two components cannot be identified separately, present the combined ECL against the drawn balance, and any excess over the gross carrying amount as a provision.
7. For SME lines that are individually reviewed and actually withdrawn when risk rises, document why the exception does or does not apply.

ECL equals PD over the relevant period multiplied by LGD and by EAD, where EAD is the drawn balance plus the credit conversion factor multiplied by the undrawn limit, probability-weighted across scenarios and discounted at the effective interest rate (or, where none is determinable for the commitment, a rate reflecting current market assessment). The behavioural life is estimated from historical account data, considering when accounts default or are closed and when the lender typically reduces limits. Credit conversion factors are generally higher in Stage 2 than in Stage 1, because customers in difficulty draw more of their limits.

Disclose: (1) the facilities to which the revolving exception is applied and the behavioural lives used; (2) how credit conversion factors and credit risk management actions are reflected; (3) the loss allowance on drawn balances and the provision on undrawn commitments, with the reconciliation by stage; (4) undrawn limits as part of the maximum exposure to credit risk; (5) sensitivity of ECL to behavioural life and conversion factors where significant.

• Limiting ECL on credit cards to the one-month or one-day contractual notice period
• measuring ECL on the drawn balance only
• applying a single conversion factor across stages
• using contractual maturity of an SME line renewed annually as its life when in practice it is rolled over
• assuming that the lender will cancel limits as soon as risk rises without evidence of past practice
• presenting the whole ECL against the drawn balance when the undrawn part can be identified
• leaving undrawn limits out of maximum credit exposure disclosures