What are expected credit losses (ECL)?

Expected credit losses (ECL) represent a forward-looking measure of estimated losses on financial instruments, primarily associated with loans, trade receivables, and other financial assets. The concept of ECL incorporates both the likelihood of default and the potential severity of loss in the event of default over the life of the financial instrument.

The correct choice highlights that ECL is an average of predicted losses that are weighted by the likelihood of default. This approach is a proactive method, which means it anticipates future credit risk rather than merely reacting to past events. By calculating expected credit losses in this way, financial institutions and companies can present a more accurate picture of the potential impairments in their financial statements, improving transparency and aiding in risk management practices.

In contrast, other options do not accurately define ECL. The total outstanding credit in a financial report means the entire amount of credit extended, without regard to the potential for loss. Losses realized from impaired assets focus on losses that have already occurred, which does not encompass the predictive nature of ECL. Lastly, historical losses from credit defaults refer specifically to past events and do not incorporate forward-looking estimates, which are essential to the ECL concept.