Staging under IFRS 9 is the process by which a lender classifies each loan, debt security, lease receivable or loan commitment into one of three stages according to how its credit quality has changed since it was first recognised. The stage decides how much loss allowance must be held and how interest income is calculated. Banks and other entities that report under international accounting standards carry out the assessment at every reporting date.
The model was introduced by IFRS 9, which took effect for annual periods beginning on or after 1 January 2018 and replaced the incurred loss approach of the previous standard. Under the old rules a provision was made only after a loss event had occurred, which was criticised after the 2008 financial crisis as "too little, too late". The staged model requires some allowance from the first day and a larger one as soon as credit risk rises meaningfully.
The three stages
The stages differ in the trigger for entry, the measure of loss and the basis for recognising interest:
| Stage | Condition | Loss allowance | Interest income |
|---|---|---|---|
| Stage 1 | No significant increase in credit risk since initial recognition | 12-month expected credit losses | On gross carrying amount |
| Stage 2 | Significant increase in credit risk, not credit-impaired | Lifetime expected credit losses | On gross carrying amount |
| Stage 3 | Credit-impaired | Lifetime expected credit losses | On net carrying amount |
Each stage has its own entry: Stage 1 credit exposure, Stage 2 credit exposure and Stage 3 credit exposure. Twelve-month expected losses are not the cash shortfalls expected in the next year; they are the lifetime losses arising from defaults that could occur within twelve months. Lifetime losses cover defaults at any time over the asset's expected life.
Moving between stages
An asset moves from Stage 1 to Stage 2 when there has been a significant increase in credit risk. This is a relative test, comparing the risk of default at the reporting date with the risk at origination, and it is supported by a rebuttable presumption that the threshold is met once payments are more than 30 days past due. An asset moves to Stage 3 when it becomes credit-impaired, for instance through default, serious financial difficulty of the borrower or a distressed concession; the standard presumes default no later than 90 days past due.
Transfers work in both directions. If credit risk improves, the asset returns to an earlier stage and the allowance is reduced, with the release credited to profit or loss. Lenders commonly apply a probation period before transferring back, particularly after forbearance. Where the terms of a loan are changed, the lender must also consider whether the loan modification is substantial enough for the old asset to be derecognised and a new one recorded in Stage 1.
Measuring the allowance
The allowance at each stage is an estimate of expected credit loss: a probability-weighted amount that reflects a range of possible outcomes, the time value of money and reasonable and supportable information about past events, current conditions and forecasts. Most banks build the estimate from three components: the probability of default, the loss given default and the exposure at default, calculated under several economic scenarios and discounted at the asset's effective interest rate.
The staging rules apply to assets measured using amortised cost accounting and to debt instruments measured at fair value through other comprehensive income. Assets measured at fair value through profit or loss are outside the model, as are equity investments.
Exceptions to the general model
Two groups of assets do not pass through the three stages in the normal way. Trade receivables and contract assets without a significant financing component always carry a lifetime allowance under the simplified approach, and entities may choose the same treatment for lease receivables. Assets that are already credit-impaired when purchased or originated are recorded with a credit-adjusted effective interest rate and thereafter recognise only changes in lifetime expected losses. An optional low credit risk exemption allows an entity to keep an asset in Stage 1 without further testing if its credit risk is low at the reporting date.
Practical and regulatory significance
The proportion of a loan book in Stages 2 and 3 is watched closely by investors and supervisors as a measure of asset quality, and banks disclose movements between stages in their financial statements. Because provisions reduce profit and therefore Common Equity Tier 1 capital, staging also affects regulatory ratios; transitional arrangements were allowed to phase in the initial capital effect. Stage 3 overlaps with, but is not identical to, the supervisory category of non-performing exposure. Models built for the internal ratings-based approach to bank capital are often adapted for accounting use, with adjustments because the accounting estimate must be point-in-time and forward-looking.
The model has drawn criticism. Judgement in setting transfer thresholds leads to differences between banks, the jump in allowance on moving to Stage 2 can be abrupt, and provisions tend to rise sharply in downturns. During periods of unusual uncertainty, banks have added management overlays on top of modelled results, which makes outcomes harder to compare. The US standard on credit losses takes a different route, requiring lifetime losses for all assets from origination with no staging. Broader context is given under impairment accounting.