In 2025, the prudential filter that allowed businesses to slowly adapt to incorporating ECL calculations into their financials ended. Businesses who don’t calculate their ECLs according to the mandated provisions may face penalties from the Central Bank of UAE. Hiring an accounting specialist to manage your reporting can help you stay compliant
What is Expected Credit Loss?
Expected credit loss, or ECL, is a method of estimating losses that might occur in the future from a potential customer or borrower. It was introduced in 2014 as part of the new accounting standard, IFRS 9 (International Financial Reporting Standards). The ECL model was a product of the Financial Crash of 2008 where banks were considered to have recognized risk too late.
The ECL requirement is mandated by the Central Bank of UAE, which is the main financial regulatory body in the country. ECL calculations take into account both the amount you’re owed and risk involved in recovering it.
The IFRS 9 replaces the IAS 39, with the aim of making financial statements more accurate and adopting a more proactive approach. Every business in the UAE must comply with the IFRS 9 standards as a way to:
- Boost investor confidence
- Align your accounting practices with international standards
- Increase the reliability of your financial statements
- Keep your company audit-ready
- Maintain compliance with Central Bank regulations
There are also two types of ECL:
- 12-month ECL: Part of the lifetime ECL, calculated over the coming 12-month period
- Lifetime ECL: Calculated over the entire lifespan of an asset
IFRS 9 vs IAS 39
The International Financial Reporting Standards (IFRS) were introduced as a clearer version of the International Accounting Standards (IAS). The IFRS are more proactive, designed to assess risk before they happen rather than after.
IFRS 9 | IAS 39 |
Introduced in 2014 | Introduced in 1999, used until 2018 |
Simpler, more consistent | Complicated, rules can be confusing |
Predicts losses early | Losses only recorded after they occur |
How to Calculate ECL Under IFRS 9
The formula for calculating ECL is:
ECL = PD × LGD × EAD
- PD = “Probability of Default”, percentage based on industry trends and their payment history
- LGD = “Loss Given Default”, the percentage you will recover if they don’t pay
- EAD = “Exposure at Default”, which is how much they owe
There are two main methods to calculate ECL:
General Approach
This approach is based on a 3-stage risk model and is used for long-term, costly loans. It is also more complicated. As a customer or borrower moves from stage to stage, the type of ECL calculation will change.
Stage 1 will have the lowest ECL estimate as the probability of the payment being made is still high. The risk of a defaulting payment increases in Stage 2 and 3.
Stage | Risk level | Type of ECL calculation |
Stage 1 | Normal | 12-month ECL |
Stage 2 | An increase in risk | Lifetime ECL |
Stage 3 | Failed to pay | Lifetime ECL |
For example, your business lends AED 100,000 to a long-term client. This client generally pays on time and has a good cash flow, so you classify the transaction under Stage 1 and use a 2% probability of default (PD) and an expected loss given default (LGD) of 30%.
So, the ECL is calculated and recorded as:
AED 100,000 × 2% × 30% = AED 600
A few months later, your client faces an unexpected circumstance and faces a financial hit. While they still haven’t defaulted the payment, there are clear signs of financial stress. The transaction is now moved to Stage 2, as there is a significant increase in credit risk.
You revise the lifetime PD to 12%, keeping the LGD the same at 30%. The ECL is now recalculated and recorded as:
AED 100,000 × 12% × 30% = AED 3,600
Simplified Approach
This method only uses lifetime ECL calculation as it is applied only to simple, short-term contracts like trade receivables. Therefore, there is no need to monitor change in credit risk.
Challenges in ECL Calculations
- Complexity in predicting risks
- Lack of historical data
- Low quality data
- Methodological errors
- Lack of proper computational systems
- Lack of coordination among interdepartmental teams
- Lack of MIS dashboards
Another huge challenge in ECL calculations is “double counting” the risk. This means you record the risk twice. It’s also important to ensure proper documentation, consider multiple sources for your probability estimates, and stay updated on regulation changes and federal laws. As this can affect your balance sheet, it’s important to work with a seasoned accountant (like the ones at A&A Associate) who can help you avoid calculation errors.
Get Expert Accounting Services with A&A Associate
A&A Associate provides expert accounting services in UAE for businesses of all sizes. We are also the largest business setup advisory in the country, offering an end-to-end solution for business setup consultants in Dubai.
