HSBC 2015 Annual Report Download - page 352

Notes on the Financial Statements (continued)
1 – Basis of preparation and significant accounting policies
HSBC HOLDINGS PLC
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credit risk reasons. For retail loans, an exception is made for individual loans that are in arrears by more than 90 days but have
been individually assessed to have no indications of impairment, and these are not classified as impaired. Under IFRS 9, HSBC
expects to determine stage 3 for these populations by considering the relevant objective evidence, primarily whether contractual
payments of either principal or interest are past due for more than 90 days, or a concession has been granted to the borrower
for economic or legal reasons relating to the borrower’s financial condition, or the loan is otherwise considered to be in default.
HSBC does not expect to rebut the presumption in IFRS 9 that loans which are 90 days past due are in default for retail loans,
even where regulatory rules permit default to be defined based on 180 days past due. The impairment allowance is expected
to be determined by the same calculation used for stage 2, with the probability of default set to 1. The result may, therefore,
not be the same as that determined by the current statistical methods and the population disclosed as stage 3 will not
necessarily correspond with that disclosed as impaired in accordance with IAS 39.
Except for retail portfolios with regulatory default definitions of 180 days, HSBC’s intention is to align the definition of default
with the regulatory definition as far as possible and for stage 3 to represent all loans which are considered defaulted or
otherwise credit impaired.
The policy on the write-off of loans and advances included on page 357 is expected to remain unchanged.
As described on page 197, the contractual terms of a loan may be modified for a number of reasons, which include
forbearance. Only some of the forbearance strategies result in loans being ‘renegotiated’. For such modifications, the current
treatment as described on pages 197-198 and 357 will remain the same under IFRS 9, except for new loans recognised
as a result of the original loan being derecognised following a renegotiation. These loans will be classified as originated credit-
impaired and will retain this classification until derecognition. For all other modifications, the general policy on derecognition
as described on page 401 will apply.
Other than originated credit-impaired loans, all other modified loans could be transferred out of stage 3 if they no longer
exhibit any evidence of being credit impaired or, in the case of renegotiated loans, there is sufficient evidence to demonstrate
a significant reduction in the risk of non-payment of future cash flows and there are no other indicators of impairment, as
described on page 198. These loans could be transferred to stages 1 or 2 based on the mechanism as described below by
comparing the risk of a default occurring at the reporting date (based on the modified contractual terms) and the risk of a
default occurring at initial recognition (based on the original, unmodified contractual terms). Any amount written off as a
result of the modification of contractual terms would not be reversed.
• Stage 2
In accordance with IFRS 9, financial assets are considered to be in stage 2 when their credit risk has increased significantly
since initial recognition so it is appropriate to recognise lifetime ECL. Since this is not a concept in IAS 39, it is likely to result
in increased allowance as the result of the recognition of lifetime ECL for populations that are not considered to be credit
impaired.
The analysis of credit risk is multifactor and the determination of whether a specific factor is relevant and its weight compared
with other factors will depend on the type of product, the characteristics of the financial instrument and the borrower, and the
geographical region. Therefore, it is not possible to provide a single set of criteria that will determine what is considered to
be a significant increase in credit risk. Since the concept is relative and significance in part depends on the credit risk at initial
recognition, credit quality disclosures that report credit grades as at the balance sheet date may not reflect the populations
in stage 2 or those that are at risk of moving to stage 2.
For wholesale portfolios and significant retail portfolios, HSBC intends to consider whether credit risk has increased significantly
since initial recognition using a combination of individual and collective information, and will reflect the increase in credit risk
at the individual loan level to the extent practicable.
The main factor that will be considered is a lifetime probability of default (‘PD’) or a 12-month PD where this provides a
reasonable approximation of changes in the lifetime risk of default, adjusted to be consistent with the current economic
conditions and the expected future economic conditions which are expected to affect credit risk. The PD will be derived from
the customer risk rating for wholesale portfolios and from the credit scores for retail portfolios. The PD for wholesale is
determined on an obligor level and for retail at the level of the individual facility. In situations where a 12-month PD would not
be appropriate, for example, where the financial instrument only has significant payment obligations beyond the next 12
months, additional factors will be considered or adjustments made to ensure that the lifetime credit risk is appropriately
considered.
The PDs will also be adjusted to incorporate the effect of economic assumptions, such as interest rates, unemployment rates
and GDP forecasts that can be statistically related to changes in PD which have an impact beyond the next 12 months. These
statistical relationships are expected to be established through the processes developed for stress testing. In addition, other
relevant factors which may not be adequately reflected in the information used to derive PDs, including past due status and
whether the financial asset is subject to additional monitoring through the watch list process for wholesale portfolios, will be
taken into account.
HSBC is in the process of calibrating and testing the thresholds or magnitude of change required and mechanisms for transfer
from stage 1 to stage 2 (and vice versa) across different portfolios so it is not possible to provide further detail at this time. The