Journal of Applied Finance & Banking

Modelling Approaches for Expected Credit Losses

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  • Abstract

    Our aim is to present two relatively simple and applicable methodologies for the consistent estimation of credit risk throughout the remaining life time of an obligor. The first methodology relies on the cash flows expected form the obligors according to his loan schedules.
     The obligor is included in an expected non-payment evolution scheme according to his IFRS 9 stage classification
     Subsequent adjustments are performed on the assumed non-payment frequency evolution (point-in-time), involving macro and micro characteristics, in order to arrive at the part of each scheduled cash flow that is expected not to be paid.
    The specific approach allows us to estimate obligor lifetime ECL and price each obligor credit risk component at the initiation of the loan granting process.
    The second methodology is simpler but more intuitive as it offers a natural extension of the already implemented Basel risk parameters. Specifically, it relies on the concepts of
     PD through the economic cycle
     Worst period LGD in the economic cycle
    It is established that the use of already calculated Basel risk parameters allows for a reconciliation to the IFRS 9 framework.

    JEL classification numbers: G21, M41
    Keywords: ECL, Credit Risk, IFRS 9, Provisions