AIFRS (IFRS outside Australia) requires collective provisions to be determined based on the observation of objective evidence of impairment. Roll rates are calculated using historical data relating to account arrears, losses and run off rates. The roll rates percentages are applied to the existing portfolio which is broken down into arrears categories. In order for the roll rate to be applied to the current portfolio, AIFRS requires either objective evidence (an impairment trigger) to be identified or an Incurred But Not Reported (IBNR) concept to be applied.

Even if we were to apply the roll rates to the “Zero” arrears bucket under an IBNR concept (given there is no objective evidence of impairment of current receivables), up to what term should we provide the provisioning for? Is it the remaining life of the portfolio, the so call “emergence period” or generically 1 year?

The remaining life can be determined based the time required until the receivables reach zero due to natural attrition or write-offs. If we used the remaining life as the term, how do we ensure that we are not taking future losses into account?

The emergence period is typically defined as the time it takes from the date a loss event occurred to the date the entity identifies it has occurred. Account status is typically updated on a monthly basis or even on a real time basis and payment default may be the only loss event identifiable on an individual exposure basis. Due to the immaterial time difference between the loss event and the identification of the event under the roll rate approach, the concept of emergence period is generally not applicable in retail banking.

Strictly speaking, if we apply the “IBNR” concept under AASB 139.AG90, we generally limit the term to 1 year. However if we do that, it is likely that we would underestimate the provisions required for the “zero” arrears bucket.

I cannot not think of a way that is feasible under the IFRS requirement and also the business requirements. There is always a forward looking component when looking at the portfolio from a business angle. Of course expected losses is not acceptable under IFRS.

I understand roll rate is still the most common provision methodology out there in the market because it really works and simple to use. However the key is to convince how does roll rate may satisfy the requirements of IFRS in retail portfolios, what sort of tweaking might be required to come up with a IFRS compliance roll rate model? Any ideas?