10. IFRS 9 Staging: the trigger that turns 12 months into a lifetime

A borrower that has never missed a payment can triple a bank's provision overnight. The trigger has a name: Stage 2.

IFRS 9 sorts every loan into three stages.

Stage 1: performing. The bank provisions the expected losses of the next 12 months.

Stage 2: credit risk has increased significantly since origination. The provision stretches to the whole remaining life of the loan.

Stage 3: default. Same lifetime horizon, but interest now accrues on the net amount.

The Stage 2 test is relative, not absolute. The bank compares the default risk today with the risk it expected the day it priced the loan. A loan born risky can stay in Stage 1; a loan born safe can fall into Stage 2 while still investment grade. Thirty days past due is the backstop: at that point IFRS 9 presumes the increase, unless the bank can prove otherwise.

❗️The jump is the point. On a long loan, the lifetime PD can be several times the 12-month one: one classification can multiply the provision overnight, with no missed payment.

And it hits the whole book at once. At end-2020, Stage 2 reached 9.1% of EU bank loans while the NPL ratio was still falling, down to 2.6%. IFRS 9 saw the risk before the defaults arrived.

Anyone who has followed a quarter-end staging run knows the feeling: the provision moves before the borrower does.

Full breakdown in the slides below. Episode 10 of my Banking Metrics Series.

How does your bank define "significant": a PD ratio threshold, a notch downgrade, or expert overlays on top?

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