Task 2 - Discuss the following concept in detail and find out the value of Expected Loss using appropriate model

a. The Three Bucket Approach of asset classification as per IFRS 9 are:

Bucket 1. Performing: This bucket, loans are broken into particular sub-buckets b ased on collateral type and loan purpose. It is a collective reserve amount and is determined on sub-bucket wise. It is also known as Initial recognition. The recognition of Expected Credit Losses (ECL) is 12 months. In this bucket, the effective interest is on gross carrying amount. For exmaple, residential estate mortgage, chattel mortgage, unsecured open-ended consumer credit, unsecured close-ended consumer credit, etc.

Bucket 2. Underperforming: In this bucket, loans are broken into particular sub-buckets b ased on collateral type and loan purpose. It is a collective reserve amount and is determined on sub-bucket wise. It can be also said as Assets with significant increase in credit risk since initial recognition. The recognition of Expected Credit Losses (ECL) is Lifetime. In this bucket, the effective interest is on gross carrying amount. For example, auto loans, business loans, etc.

Bucket 3. Nonperforming: This bucket is for any loan which becomes seriously impaired, such as in the case of long-term arrear as well as for the institution largest exposures that are in arrears. It is also known as Credit-impaired assets. The recognition of Expected Credit Losses (ECL) is Lifetime. In this bucket, the effective interest is on net book value.