MPSAS 41 Is Coming: Why Agencies With Large Loan Portfolios Should Start Preparing Now

MPSAS 41, Financial Instruments, becomes effective for annual financial statements covering periods beginning on or after 1 January 2030.

At first glance, 2030 may appear some distance away.

For an agency with a small number of financial assets, that may provide considerable time to prepare.

For an agency administering thousands — or potentially hundreds of thousands — of loans or financing accounts, however, the implementation challenge may be very different.

The difficult part may not simply be calculating an impairment allowance in 2030.

It may be having the right historical credit-risk data available when the calculation needs to be made.

MPSAS 41 Series — Part 1. This article looks at why agencies with significant loan portfolios should begin preparing early. Part 2 will explain the expected credit loss concept and why losses may need to be recognised before a borrower actually defaults.

What changes under MPSAS 41?

Under the existing MPSAS 29 impairment model, an impairment loss on a loan or receivable is generally recognised when there is objective evidence that a loss has been incurred.

In other words, the accounting looks for evidence that something has already happened.

Examples may include financial difficulty, default, delinquency or other events indicating that the expected cash flows from a financial asset have been adversely affected.

MPSAS 41 introduces a different approach.

It requires entities to recognise an allowance based on expected credit losses, or ECL, for financial instruments that fall within the impairment requirements of the Standard.

The concept is more forward-looking.

Instead of asking only:

“Has a loss event already occurred?”

the accounting increasingly asks:

“Based on what we know today, what credit losses should we reasonably expect?”

That is an important change in thinking.

Why is this particularly important for loan-giving agencies?

Consider an agency whose core activities include providing loans or financing to:

• students;
• entrepreneurs;
• small businesses;
• farmers;
• property owners;
• members of particular communities; or
• other qualifying beneficiaries.

The agency may have operated the programme for many years.

Its system may already capture:

• original loan amount;
• instalment amount;
• outstanding balance; and
• whether an account is in arrears.

Those fields may be sufficient for collection and operational purposes.

They may not necessarily be sufficient for MPSAS 41.

Expected credit loss accounting requires an entity to consider credit risk more systematically.

Depending on the portfolio and methodology adopted, relevant information may include:

• repayment history;
• days past due;
• previous restructurings;
• borrower characteristics;
• changes in borrower risk;
• historical defaults;
• amounts ultimately recovered after default;
• write-offs;
• collateral or other credit enhancements; and
• information about current and expected economic conditions.

The challenge therefore extends beyond the finance department.

Historical data cannot simply be created in 2030

Suppose an agency reaches 2030 and decides to develop its ECL methodology.

It then asks:

“What percentage of borrowers historically default after becoming 30, 60 or 90 days overdue?”

The system may not contain that history.

Or management may ask:

“When borrowers default, how much do we normally recover over the following years?”

Again, that information may never have been captured in a structured form.

A current outstanding balance can be obtained today.

A five-year history of how accounts moved from performing to delinquent, defaulted, restructured and eventually recovered is much harder to reconstruct after the event.

That is why implementation planning should not necessarily wait until the year before MPSAS 41 becomes mandatory.

MPSAS 41 looks beyond whether an account is overdue today

One major feature of the new model is that credit risk is not assessed solely by looking at whether payments are currently past due.

MPSAS 41 requires entities to consider reasonable and supportable information, including forward-looking information where it is available without undue cost or effort.

This may include information specific to the borrower as well as broader economic conditions.

For an agency with a large loan portfolio, that raises practical questions.

Does the agency currently have a way to identify borrowers whose credit risk has deteriorated?

Does it retain the original risk information from when the loan was first recognised?

Can it distinguish between temporary arrears and a meaningful deterioration in credit quality?

Can loans with similar credit-risk characteristics be grouped together?

Can historical experience be linked to current and expected conditions?

These are not simply year-end journal-entry questions.

They are data and portfolio management questions.

Large portfolios create a different problem

An agency with ten loans may be able to assess each borrower individually.

An agency with 100,000 accounts cannot realistically analyse every borrower manually at each reporting date.

Large portfolios usually require some form of:

• segmentation;
• risk grouping;
• historical analysis;
• automated data extraction; and
• repeatable methodology.

For example, loans might need to be analysed according to characteristics such as:

• type of financing;
• borrower category;
• repayment behaviour;
• age of arrears;
• geography;
• collateral;
• restructuring history; or
• other characteristics that meaningfully affect credit risk.

The appropriate segmentation will depend on the nature of the portfolio.

The important point is that the accounting model depends heavily on the quality and structure of the underlying data.

The change is bigger than simply changing an impairment percentage

It may be tempting to approach MPSAS 41 by saying:

“We currently provide 5% impairment. Under MPSAS 41, we just need to find a new percentage.”

That would miss the bigger issue.

Expected credit loss is not simply a different percentage applied to the same year-end receivable balance.

The methodology considers the risk of credit loss and, where appropriate, how that risk has changed over time.

Under the general model, financial instruments for which credit risk has not increased significantly since initial recognition are generally subject to 12-month expected credit losses.

Where credit risk has increased significantly, the allowance generally moves to lifetime expected credit losses.

That means the entity needs information not only about the balance today, but also about the credit-risk journey of the instrument.

We will explore that mechanics separately in this series.

Finance may not own the information it needs

Another implementation challenge is organisational.

The finance department may prepare the financial statements.

But information relevant to ECL may sit with:

• loan administration;
• credit assessment;
• collections;
• legal;
• recovery teams;
• information technology; or
• programme operations.

For example, the collections department may know that a borrower entered a restructuring programme.

Legal may know that recovery action has commenced.

The lending system may record arrears.

Finance may only receive the final outstanding balance.

Under MPSAS 41, those pieces of information may need to come together.

Implementation may therefore require cross-departmental ownership, rather than being treated solely as a finance project.

What should agencies consider doing now?

Preparing for MPSAS 41 does not mean an agency needs to build a sophisticated ECL model immediately.

A more practical first step is to understand what already exists.

Agencies with significant lending activities can begin by asking:

1. What loan and financing portfolios do we currently have?
2. How many active accounts are there?
3. What borrower information is captured at origination?
4. What repayment and arrears history is retained?
5. Can we identify when an account first became delinquent?
6. Can we identify restructurings and modifications?
7. Do we retain historical write-off and recovery information?
8. Can current balances be linked to historical borrower behaviour?
9. What credit-risk indicators are used operationally today?
10. How many years of reliable historical data are available?

The answers may reveal that much of the required information already exists.

They may also reveal significant gaps.

Finding those gaps several years before implementation is very different from finding them during the first MPSAS 41 year-end closing.

The first step may be a data assessment, not an accounting calculation

MPSAS 41 will eventually require accounting judgments, assumptions and calculations.

But for agencies with large loan portfolios, preparation may need to start somewhere more basic:

What information do we have about our borrowers and how their credit risk has changed over time?

If that information is available, building an appropriate methodology becomes easier.

If it is missing, inconsistent or stored across multiple systems, the implementation exercise can become significantly more difficult.

2030 therefore should not only be viewed as the year in which a new impairment calculation begins.

For some agencies, the years before 2030 may be the opportunity to build the data history, processes and internal understanding needed to make that calculation meaningful.

Part 2 of this series will look at the core ECL question: why does MPSAS 41 require an expected loss to be recognised even when a borrower has not yet defaulted?

Sources & references

• JANM – MPSAS 41, Financial Instruments
• JANM – MPSAS 29, Financial Instruments: Recognition and Measurement
• JANM – Malaysian Public Sector Accounting Standards (MPSAS)
• IPSASB – Supporting Resources: IPSAS 41, Financial Instruments