1. IFRS 9 defines credit loss in terms of "cash shortfall" but provides little guidance on how to compute it, leading to ambiguity. Cash shortfall can be measured directly by discounting individual cash flows or indirectly using methods like vintage analysis.
2. Loss given default (LGD) is commonly used as a proxy for cash shortfall. LGD is the amount of credit lost in a default and can be estimated using market, implied market, or workout approaches. Workout LGD uses estimated cash flows from recovery processes.
3. Statistical, judgmental, and hybrid methods can be used to estimate LGD. Statistical methods regress recoveries on variables but require large data. Judgmental methods use
On 18th December 2015, the Basel Committee for Banking Supervision (BCBS) published its final insights on sound credit risk and accounting practices associated with the implementation of IFRS 9 Expected Credit Losses (ECL) accounting frameworks.
In this post, we will be highlighting and deliberating upon some of the key issues which have been discussed in the BCBS guidance note, and their impact on various banks.
Continuing with our updates on the key aspects of IFRS 9 Implementation, our current post (attached) talks about “IFRS 9 Impairment Solution”. The post aims to provide key insights, which might assist banks’ in selecting a strategic solution that will future-proof the investment towards successful IFRS 9 implementation. The post enumerates on the key desirable features both from functional and technical viewpoints, which a strategic IFRS 9 solution should possess and will benefit our readers to make an important choice.
As discussed in our previous blog, PIT PD describes an expectation of the future, starting from the current situation and integrating all relevant cyclical changes & all values of the obligor idiosyncratic effect with appropriate probabilities. A PIT PD mimics the observed default rates over a period of time. TTC PDs, in contrast, reflect circumstances anticipated over an extremely long period, and thus nullify the effects of credit cycle. Basing it on these definitions, the current article focuses on range of PD Calibration approaches for aligning internal rating model output with actual default rates.
Aptivaa is pleased to launch a series of blogs to apprise readers of some of the key aspects related mostly to Impairment Modeling, for compliance with the new accounting standards (IFRS 9), as well as to have a conversation with the readers about the challenges that banks are facing in their implementation efforts.
A key metric that summarizes the credit worthiness of a bank’s obligor is the Probability of Default (PD). Besides credit worthiness assessment and capital computation under IRB, PD is one of the key metrics required in the updated IFRS 9 accounting standards. At present, there are many PD related terminologies used in the banking industry, such as: PIT PD, TTC PD, 12-month PD and so on. Such a wide spectrum of terminologies has led to confusion among users, especially when it comes to IFRS 9, which lays special focus on PIT PD and lifetime PD. This blog intends to clarify these key terminologies.
As the methodologies for IFRS 9 Implementation are still evolving, many banks are in the process of developing a roadmap towards implementation and are still evaluating methodologies that are likely to conform to the principles of proportionality and materiality. To this end, Banks being advised are to develop a Target Operating Model (TOM) design, which seeks to identify and document the work program required to meet IFRS 9 requirements on Impairment modelling and ECL estimation.
Continuing with our updates on the key aspects of IFRS 9 Implementation, our current post (attached) talks about “Exposure at Default (EAD)” where, possible uses and business interpretation nuances of terms linked to EAD are highlighted. The post enumerates on the computation methods of EAD and the modeling approaches available for each of the methods with key consideration points from Basel and IFRS9 perspectives highlighted in between for the readers.
We look forward to your valuable feedback on the current article or the challenges faced by you in IFRS9 implementation.
In our second post ‘building blocks of Impairment Modeling’, we had highlighted that IFRS 9 uses a ‘three stage model’ for measurement of ECL, and one of the major challenges of implementing this model was tracking and determining whether there has been a significant increase in risk of a credit exposure since origination. This blog post delves into the intricacies related to the three stage model, and some nuances that need to be considered for a bank looking to implement IFRS 9.
On 18th December 2015, the Basel Committee for Banking Supervision (BCBS) published its final insights on sound credit risk and accounting practices associated with the implementation of IFRS 9 Expected Credit Losses (ECL) accounting frameworks.
In this post, we will be highlighting and deliberating upon some of the key issues which have been discussed in the BCBS guidance note, and their impact on various banks.
Continuing with our updates on the key aspects of IFRS 9 Implementation, our current post (attached) talks about “IFRS 9 Impairment Solution”. The post aims to provide key insights, which might assist banks’ in selecting a strategic solution that will future-proof the investment towards successful IFRS 9 implementation. The post enumerates on the key desirable features both from functional and technical viewpoints, which a strategic IFRS 9 solution should possess and will benefit our readers to make an important choice.
As discussed in our previous blog, PIT PD describes an expectation of the future, starting from the current situation and integrating all relevant cyclical changes & all values of the obligor idiosyncratic effect with appropriate probabilities. A PIT PD mimics the observed default rates over a period of time. TTC PDs, in contrast, reflect circumstances anticipated over an extremely long period, and thus nullify the effects of credit cycle. Basing it on these definitions, the current article focuses on range of PD Calibration approaches for aligning internal rating model output with actual default rates.
Aptivaa is pleased to launch a series of blogs to apprise readers of some of the key aspects related mostly to Impairment Modeling, for compliance with the new accounting standards (IFRS 9), as well as to have a conversation with the readers about the challenges that banks are facing in their implementation efforts.
A key metric that summarizes the credit worthiness of a bank’s obligor is the Probability of Default (PD). Besides credit worthiness assessment and capital computation under IRB, PD is one of the key metrics required in the updated IFRS 9 accounting standards. At present, there are many PD related terminologies used in the banking industry, such as: PIT PD, TTC PD, 12-month PD and so on. Such a wide spectrum of terminologies has led to confusion among users, especially when it comes to IFRS 9, which lays special focus on PIT PD and lifetime PD. This blog intends to clarify these key terminologies.
As the methodologies for IFRS 9 Implementation are still evolving, many banks are in the process of developing a roadmap towards implementation and are still evaluating methodologies that are likely to conform to the principles of proportionality and materiality. To this end, Banks being advised are to develop a Target Operating Model (TOM) design, which seeks to identify and document the work program required to meet IFRS 9 requirements on Impairment modelling and ECL estimation.
Continuing with our updates on the key aspects of IFRS 9 Implementation, our current post (attached) talks about “Exposure at Default (EAD)” where, possible uses and business interpretation nuances of terms linked to EAD are highlighted. The post enumerates on the computation methods of EAD and the modeling approaches available for each of the methods with key consideration points from Basel and IFRS9 perspectives highlighted in between for the readers.
We look forward to your valuable feedback on the current article or the challenges faced by you in IFRS9 implementation.
In our second post ‘building blocks of Impairment Modeling’, we had highlighted that IFRS 9 uses a ‘three stage model’ for measurement of ECL, and one of the major challenges of implementing this model was tracking and determining whether there has been a significant increase in risk of a credit exposure since origination. This blog post delves into the intricacies related to the three stage model, and some nuances that need to be considered for a bank looking to implement IFRS 9.
As the race against time to comply with IFRS 9 guidelines begins, several software solutions are being bandied about as a quick fix solution for automating the entire impairment modelling process. While automating is definitely the way to go in initiatives such as these, the question remains as to whether the software architecture should be of a strategic integrated nature or one that is decoupled and modular. In Aptivaa, we believe the answer to this lies in the 4Rs question: Readiness, Reflectiveness, Redundancy and Regularity.
In our earlier blog, we discussed PD terminology and PD calibration approaches as applicable to the IFRS 9 framework. In this blog, we have discussed the methodologies for adjusting PDs for the ‘forward-looking’ macroeconomic scenarios and development of PD Term Structure.
The blog provide some key insights on the subject – as to how to compute EIR for fixed or floating rate instruments, how to compute EIR for products which involves both interest income and fee income, what are the challenges which banks might face while computing EIR, what are the operational simplifications which banks might consider while computing EIR.
Banks are scrambling to meet with IFRS 9 guidelines and are setting down on the path to implement various ECL estimation methodologies and models. But a topic that hasn’t been given enough attention is the need for governance of these models and the attendant model risk management framework that needs to be set up to lend credibility to the model estimates. This blog touches upon the need for validation of models and how model risk governance has become paramount in view of the new guidelines.
In the backdrop of the buzz that Interest Rate Risk in the Banking Book (IRRBB) has generated in the banking industry, Aptivaa is pleased to launch a series of articles providing our perspective on various issues highlighted by our esteemed clients during interactions in the recent months. This post gives an overview of the revised guidelines on IRRBB which has been issued by the Basel Committee, the approaches and the associated challenges in the implementation of IRRBB framework for all internationally active banks.We look forward to your valuable feedback on the current article or the challenges faced by you in IRRBB implementation.
Continuing with our updates on the key aspects of IFRS 9 Implementation, our current post (attached) talks about “Impairment Modelling in Retail ” where, key challenges are highlighted through questions and different solutions are proposed to address the same. The post attempts to address some key implementation challenges such as; Which approach to follow for analysis of retail portfolios?, What timeframe to consider for estimating lifetime of retail products?, How to link forward looking information with PDs? How to carry out Stage Allocation? And, what are the methods for calculation of ECL for Retail Portfolios?
In the backdrop of the buzz that IFRS-9 has generated in the banking industry, Aptivaa is pleased to launch a series of articles providing our perspective on various issues highlighted by our esteemed clients during interactions in the recent months. First in the series is our take on the latest BCBS paper which requires ‘high quality’, ‘robust’ & ‘consistent’ implementation of Expected Credit Loss (ECL) framework for all internationally active banks.
Key highlights from BCBS guidance are:
§ Banks should consider the principle of proportionality and materiality while finalizing the methodology for ECL estimation
§ BCBS allows the immediate reversal of allowance in case of credit quality improvement, recognising that ECL accounting frameworks are symmetrical
§ Limited use of IFRS 9 practical expedients such as, more than 30 days past due, low credit risk exemption & information set
§ Inclusion of forward looking information and macroeconomic forecasts to the historical information in the ECL estimation process
§ Requirement of robust policies and procedures for model governance and validation which is in line with regulatory requirements for Basel II IRB purposes
Please find enclosed the white paper, which provides in-depth details of the key aspects discussed by the Basel Committee and our view on the same.
This is the second post in the series of articles we have launched on various topics in the area of Asset Liability Management. Our prior post covered the recently issued Basel guidelines on Interest Rate Risk in the Banking Book (IRRBB).
A key aspect of the guidelines is the requirement for modeling of interest rate behavior of various balance sheet products. In this post we explore the nature of balance sheet cash flows, their key characteristics and sensitivity to market liquidity and interest rate movements. We also highlight how a deeper understanding of cash flow behavior is required to effectively manage the liquidity of the bank and also price balance sheet products. We focus particularly on the non-maturing deposits which form the single largest source of non-contractual cash flows of any bank.
rest rate modeling assumptions.
his is the second post in the series of articles we have launched on various topics in the area of Asset Liability Management. Our prior post covered the recently issued Basel guidelines on Interest Rate Risk in the Banking Book (IRRBB).
A key aspect of the guidelines is the requirement for modeling of interest rate behavior of various balance sheet products. In this post we explore the nature of balance sheet cash flows, their key characteristics and sensitivity to market liquidity and interest rate movements. We also highlight how a deeper understanding of cash flow behavior is required to effectively manage the liquidity of the bank and also price balance sheet products. We focus particularly on the non-maturing deposits which form the single largest source of non-contractual cash flows of any bank.
We look forward to your valuable feedback on the current article. We are also keen on hearing about any challenges faced by you in developing balance sheet liquidity and interest rate modeling assumptions.
IFRS9 is a new international accounting standard that will affect debt owners, including mortgage lenders and Special Purpose Vehicles, from January 2018. It will replace IAS39.
At present under IAS39, lenders need to calculate an expected loss value for just those accounts that are impaired. Under IFRS9, a lender must reassess the probability of any of their customers defaulting and the resulting expected losses for all exposures - and this will need to be carried out each reporting period.
This white paper explains the challenges IFRS9 presents and how HML’s can help lenders and SPVs with accurate provisioning.
Strategic implications of IFRS9 oliver wymanGeoff Holmes
IFRS9 will fundamentally change the level and dynamics of credit provisions, and will result in significantly diminished returns for some segments. To date, most banks have focussed on ensuring compliance, but with the 2018 implementation deadline approaching attention is turning to understanding and mitigating the impacts.
IFRS9 materially impacts lending economics, particularly for consumer credit and SME products where some segments will be significantly less attractive than today. Given all lenders are affected, this represents a challenge and an opportunity. Those who develop their responses early and optimise their actions stand a good chance of getting ahead of the competition.
The paper attached examines how IFRS9 impacts profitability, where the effects are most material, and how lenders can respond.
IFRS 9 : Accounting Meets Risk Management by En Shah ZainAlbakry Azis
"IFRS 9 : Accounting Meets Risk Management - Challenged and Solutions for Fixed Income Instruments" was presented by En Shah Zain, Chief Business Officer from Bond Pricing Agency Malaysia during the BPAM Annual Client Update 2016.
Market Practice Series (Credit Losses Modeling)Yahya Kamel
The Central Bank of Egypt “CBE” has adopted IFRS in year 2008. In specific IAS 39 has a discussion about implementing a model that can derive the incurred credit losses for a pool of receivables/ loans, which was quite open for market development & practical initiatives.
From the part of the CBE, it has adopted same approach, which led to some wide different market practices, logic, and interpretations, which sometimes have been questionable on a wide scale basis!
So, I've thought to develop some sort of materials that can serve as a practical guidance for quantifying the credit risk, using different simple models, based on Basel II definitions of the risk components.
The intended users of this material are the credit risk professionals who conduct risk analysis, implement risk management policies, or/and are in charge of quantifying the credit risk for a loan portfolio (corporate & retail).
Also, other professionals or officers complying with IFRS, or CBE GAAP.
As the race against time to comply with IFRS 9 guidelines begins, several software solutions are being bandied about as a quick fix solution for automating the entire impairment modelling process. While automating is definitely the way to go in initiatives such as these, the question remains as to whether the software architecture should be of a strategic integrated nature or one that is decoupled and modular. In Aptivaa, we believe the answer to this lies in the 4Rs question: Readiness, Reflectiveness, Redundancy and Regularity.
In our earlier blog, we discussed PD terminology and PD calibration approaches as applicable to the IFRS 9 framework. In this blog, we have discussed the methodologies for adjusting PDs for the ‘forward-looking’ macroeconomic scenarios and development of PD Term Structure.
The blog provide some key insights on the subject – as to how to compute EIR for fixed or floating rate instruments, how to compute EIR for products which involves both interest income and fee income, what are the challenges which banks might face while computing EIR, what are the operational simplifications which banks might consider while computing EIR.
Banks are scrambling to meet with IFRS 9 guidelines and are setting down on the path to implement various ECL estimation methodologies and models. But a topic that hasn’t been given enough attention is the need for governance of these models and the attendant model risk management framework that needs to be set up to lend credibility to the model estimates. This blog touches upon the need for validation of models and how model risk governance has become paramount in view of the new guidelines.
In the backdrop of the buzz that Interest Rate Risk in the Banking Book (IRRBB) has generated in the banking industry, Aptivaa is pleased to launch a series of articles providing our perspective on various issues highlighted by our esteemed clients during interactions in the recent months. This post gives an overview of the revised guidelines on IRRBB which has been issued by the Basel Committee, the approaches and the associated challenges in the implementation of IRRBB framework for all internationally active banks.We look forward to your valuable feedback on the current article or the challenges faced by you in IRRBB implementation.
Continuing with our updates on the key aspects of IFRS 9 Implementation, our current post (attached) talks about “Impairment Modelling in Retail ” where, key challenges are highlighted through questions and different solutions are proposed to address the same. The post attempts to address some key implementation challenges such as; Which approach to follow for analysis of retail portfolios?, What timeframe to consider for estimating lifetime of retail products?, How to link forward looking information with PDs? How to carry out Stage Allocation? And, what are the methods for calculation of ECL for Retail Portfolios?
In the backdrop of the buzz that IFRS-9 has generated in the banking industry, Aptivaa is pleased to launch a series of articles providing our perspective on various issues highlighted by our esteemed clients during interactions in the recent months. First in the series is our take on the latest BCBS paper which requires ‘high quality’, ‘robust’ & ‘consistent’ implementation of Expected Credit Loss (ECL) framework for all internationally active banks.
Key highlights from BCBS guidance are:
§ Banks should consider the principle of proportionality and materiality while finalizing the methodology for ECL estimation
§ BCBS allows the immediate reversal of allowance in case of credit quality improvement, recognising that ECL accounting frameworks are symmetrical
§ Limited use of IFRS 9 practical expedients such as, more than 30 days past due, low credit risk exemption & information set
§ Inclusion of forward looking information and macroeconomic forecasts to the historical information in the ECL estimation process
§ Requirement of robust policies and procedures for model governance and validation which is in line with regulatory requirements for Basel II IRB purposes
Please find enclosed the white paper, which provides in-depth details of the key aspects discussed by the Basel Committee and our view on the same.
This is the second post in the series of articles we have launched on various topics in the area of Asset Liability Management. Our prior post covered the recently issued Basel guidelines on Interest Rate Risk in the Banking Book (IRRBB).
A key aspect of the guidelines is the requirement for modeling of interest rate behavior of various balance sheet products. In this post we explore the nature of balance sheet cash flows, their key characteristics and sensitivity to market liquidity and interest rate movements. We also highlight how a deeper understanding of cash flow behavior is required to effectively manage the liquidity of the bank and also price balance sheet products. We focus particularly on the non-maturing deposits which form the single largest source of non-contractual cash flows of any bank.
rest rate modeling assumptions.
his is the second post in the series of articles we have launched on various topics in the area of Asset Liability Management. Our prior post covered the recently issued Basel guidelines on Interest Rate Risk in the Banking Book (IRRBB).
A key aspect of the guidelines is the requirement for modeling of interest rate behavior of various balance sheet products. In this post we explore the nature of balance sheet cash flows, their key characteristics and sensitivity to market liquidity and interest rate movements. We also highlight how a deeper understanding of cash flow behavior is required to effectively manage the liquidity of the bank and also price balance sheet products. We focus particularly on the non-maturing deposits which form the single largest source of non-contractual cash flows of any bank.
We look forward to your valuable feedback on the current article. We are also keen on hearing about any challenges faced by you in developing balance sheet liquidity and interest rate modeling assumptions.
IFRS9 is a new international accounting standard that will affect debt owners, including mortgage lenders and Special Purpose Vehicles, from January 2018. It will replace IAS39.
At present under IAS39, lenders need to calculate an expected loss value for just those accounts that are impaired. Under IFRS9, a lender must reassess the probability of any of their customers defaulting and the resulting expected losses for all exposures - and this will need to be carried out each reporting period.
This white paper explains the challenges IFRS9 presents and how HML’s can help lenders and SPVs with accurate provisioning.
Strategic implications of IFRS9 oliver wymanGeoff Holmes
IFRS9 will fundamentally change the level and dynamics of credit provisions, and will result in significantly diminished returns for some segments. To date, most banks have focussed on ensuring compliance, but with the 2018 implementation deadline approaching attention is turning to understanding and mitigating the impacts.
IFRS9 materially impacts lending economics, particularly for consumer credit and SME products where some segments will be significantly less attractive than today. Given all lenders are affected, this represents a challenge and an opportunity. Those who develop their responses early and optimise their actions stand a good chance of getting ahead of the competition.
The paper attached examines how IFRS9 impacts profitability, where the effects are most material, and how lenders can respond.
IFRS 9 : Accounting Meets Risk Management by En Shah ZainAlbakry Azis
"IFRS 9 : Accounting Meets Risk Management - Challenged and Solutions for Fixed Income Instruments" was presented by En Shah Zain, Chief Business Officer from Bond Pricing Agency Malaysia during the BPAM Annual Client Update 2016.
Market Practice Series (Credit Losses Modeling)Yahya Kamel
The Central Bank of Egypt “CBE” has adopted IFRS in year 2008. In specific IAS 39 has a discussion about implementing a model that can derive the incurred credit losses for a pool of receivables/ loans, which was quite open for market development & practical initiatives.
From the part of the CBE, it has adopted same approach, which led to some wide different market practices, logic, and interpretations, which sometimes have been questionable on a wide scale basis!
So, I've thought to develop some sort of materials that can serve as a practical guidance for quantifying the credit risk, using different simple models, based on Basel II definitions of the risk components.
The intended users of this material are the credit risk professionals who conduct risk analysis, implement risk management policies, or/and are in charge of quantifying the credit risk for a loan portfolio (corporate & retail).
Also, other professionals or officers complying with IFRS, or CBE GAAP.
By 1st December 2015, BCBS-IOSCO rules mean that all eligible financial and non-financial counterparties must be able to exchange bilateral Variation Margin (VM) and Initial Margin (IM) with their OTC derivatives counterparties. The consequences of this extend far beyond methodology, requiring a re-evaluation of the whole end to end workflow.
Credit Impairment under IFRS 9 for BanksFaraz Zuberi
A quick overview of credit impairment under IFRS 9 for banks. Those with limited or no understanding of new requirements for loan loss accounting, will get a quick high level understanding of an accounting standard that is the most significant change in accounting for loan losses in more than a decade.
In depth: New financial instruments impairment modelPwC
On June 16, 2016, the FASB issued Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326) (the “ASU”). The ASU introduces a new model for recognizing credit losses on financial instruments based on an estimate of current expected credit losses. The new model will apply to: (1) loans, accounts receivable, trade receivables, and other financial assets measured at amortized cost, (2) loan commitments and certain other off-balance sheet credit exposures, (3) debt securities and other financial assets measured at fair value through other comprehensive income, and (4) beneficial interests in securitized financial assets.
Counterparty Credit RISK | Evolution of standardised approachGRATeam
In this Article, we have made a focus on the new standard methodology (SA-CCR) for computing the EAD related to Counterparty Credit Risk portfolios. The implementation of a SA-CCR approach will become increasingly important for the Banks given the publication of the finalised Basel III reforms; in which it will require from financial institutions to compute an output floor to compare their level of RWAs between Internal and Standard approaches.
Counterparty Credit Risk | Evolution of
the standardised approach to determine the EAD of counterparties
This article focuses on Counterparty Credit Risk. The topic of this article is on the evolution and need of standardised method for the assessment of Exposure at Default of counterparties and their Capitalisation under regulatory requirements.
Aptivaa is pleased to launch a series of blogs to apprise readers of some of the key aspects related mostly to Impairment Modeling, for compliance with the new accounting standards (IFRS 9), as well as to have a conversation with the readers about the challenges that banks are facing in their implementation efforts
IFRS 9 Implementation : Using the Z-score approach as a KRI to identify adverse credit deterioration for Stage Transition from 1 to stages 2/3 in IFRS 9 Modeling
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Bank Case Assignment
Ratche93
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CaseRequirements.pdf
Home>Business & Finance homework help>Bank Case Assignment
What is this Project’s Objective?
This project is designed to improve your ability to analyze a particular bank's performance. The
emphasis should be to explore your bank from a regulator’s point of view. In that respect you
should address the six CAMELS components and try to identify any "red flags" that could indicate
potential problems in your bank. The Excel file under the name of “Bank Financial Analysis”
should be used to capture the financial data for your bank and to show the associated financial
ratios. You should be able to find all your data in your bank’s Uniform Bank Performance Report
(UBPR) which is available at www.ffiec.gov. Your written report should be no less than 5 pages
long (typed, double-spaced) not including the Excel worksheet. The six CAMELS components
are: Capital adequacy; Asset quality; Management quality; Earnings record; Liquidity position;
and Sensitivity to market risk. Following is a more detailed listing of the items that you need to
address:
A. Liquidity
Consider your bank’s Uniform Bank Performance Report (UBPR) and provide an overview of your
bank’s liquidity by reviewing the following areas:
1. Liquidity and Funding Ratios especially the Net Non-Core Funding Dependence
and Loan to Assets Ratios – The first ratio measures the degree to which the bank is
funding longer-term assets (loans, securities that mature in more than one year, etc.) with
non-core funding. Non-core funding includes funding that can be very sensitive to
changes in interest rates such as brokered deposits, CDs greater than $100,000, and
borrowed money. Higher ratios reflect a reliance on funding sources that may not be
available in times of financial stress or adverse changes in market conditions. What are
the trends in these ratios? How do they compare to the peer?
2. The availability of liquid assets readily convertible to cash without undue loss-
Consider Federal funds sold, available for sale securities, loans for sale, etc.
3. Core deposit/asset growth - Are core deposits capable of funding anticipated asset
growth?
4. Diversification of funding sources - A bank with strong liquidity has a strong core
deposit base, established borrowings lines, and procedures in place for acquiring
internet-based or other forms of emergency borrowing.
5. External Forces - Economic conditions, competition, marketing efforts, etc. ...
In response to the 2008 financial crisis, regulators and investors put pressure on the FASB and IASB to develop models that would require financial institutions to recognize losses earlier in the credit cycle. Measuring credit loss on Pools of loans...
Current Write-off Rates and Q-factors in Roll-rate MethodGraceCooper18
Under the current CECL standard introduced by Accounting Standards Updates (ASU) 2016-13, there are several measurement approaches that financial institutions can use to estimate expected credit losses. Among these, the Roll-rate method, which uses historical trends in credit write-offs and delinquency, is the most popular. Historical roll rates are used to predict ultimate losses.
Similar to Cash Shortfall & LGD - Two Sides of the Same Coin (20)
How to get verified on Coinbase Account?_.docxBuy bitget
t's important to note that buying verified Coinbase accounts is not recommended and may violate Coinbase's terms of service. Instead of searching to "buy verified Coinbase accounts," follow the proper steps to verify your own account to ensure compliance and security.
Abhay Bhutada Leads Poonawalla Fincorp To Record Low NPA And Unprecedented Gr...Vighnesh Shashtri
Under the leadership of Abhay Bhutada, Poonawalla Fincorp has achieved record-low Non-Performing Assets (NPA) and witnessed unprecedented growth. Bhutada's strategic vision and effective management have significantly enhanced the company's financial health, showcasing a robust performance in the financial sector. This achievement underscores the company's resilience and ability to thrive in a competitive market, setting a new benchmark for operational excellence in the industry.
The European Unemployment Puzzle: implications from population agingGRAPE
We study the link between the evolving age structure of the working population and unemployment. We build a large new Keynesian OLG model with a realistic age structure, labor market frictions, sticky prices, and aggregate shocks. Once calibrated to the European economy, we quantify the extent to which demographic changes over the last three decades have contributed to the decline of the unemployment rate. Our findings yield important implications for the future evolution of unemployment given the anticipated further aging of the working population in Europe. We also quantify the implications for optimal monetary policy: lowering inflation volatility becomes less costly in terms of GDP and unemployment volatility, which hints that optimal monetary policy may be more hawkish in an aging society. Finally, our results also propose a partial reversal of the European-US unemployment puzzle due to the fact that the share of young workers is expected to remain robust in the US.
What price will pi network be listed on exchangesDOT TECH
The rate at which pi will be listed is practically unknown. But due to speculations surrounding it the predicted rate is tends to be from 30$ — 50$.
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I will leave the telegram contact of my personal pi vendor to trade with.
@Pi_vendor_247
when will pi network coin be available on crypto exchange.DOT TECH
There is no set date for when Pi coins will enter the market.
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Once they are available, users will be able to exchange other cryptocurrencies for Pi coins on designated exchanges.
But for now the only way to sell your pi coins is through verified pi vendor.
Here is the telegram contact of my personal pi vendor
@Pi_vendor_247
2. Elemental Economics - Mineral demand.pdfNeal Brewster
After this second you should be able to: Explain the main determinants of demand for any mineral product, and their relative importance; recognise and explain how demand for any product is likely to change with economic activity; recognise and explain the roles of technology and relative prices in influencing demand; be able to explain the differences between the rates of growth of demand for different products.
How Does CRISIL Evaluate Lenders in India for Credit RatingsShaheen Kumar
CRISIL evaluates lenders in India by analyzing financial performance, loan portfolio quality, risk management practices, capital adequacy, market position, and adherence to regulatory requirements. This comprehensive assessment ensures a thorough evaluation of creditworthiness and financial strength. Each criterion is meticulously examined to provide credible and reliable ratings.
where can I find a legit pi merchant onlineDOT TECH
Yes. This is very easy what you need is a recommendation from someone who has successfully traded pi coins before with a merchant.
Who is a pi merchant?
A pi merchant is someone who buys pi network coins and resell them to Investors looking forward to hold thousands of pi coins before the open mainnet.
I will leave the telegram contact of my personal pi merchant to trade with
@Pi_vendor_247
1. Cash Shortfall & LGD –
Two Sides of the Same Coin
ISSUE 11
Contact: IFRS9.Insights@aptivaa.com | Website: www.aptivaa.com | www.linkedin.com/company/aptivaa Page 1
Under IFRS 9, Expected Credit Loss (ECL) for financial instruments should be an unbiased and probability-
weighted amount, which is determined by evaluating a range of possible outcomes. To meet this
requirement, banks will be required to determine “Expected” default path of the financial instruments and
estimate the possible “Credit Losses” along that path.
IFRS 9 defines “Credit Loss” in terms of “Cash Shortfall” or credit loss estimation through projected cash
flow discounting. However, there is little explicit information available as to how “Cash Shortfall” should be
computed; should it be computed separately or along with “Expected” default path of the borrower, leading
to ambiguity around the subject. IFRS 9 has specifically given inputs on Probability of Default (PD)
estimation based on forward-looking scenarios and computation of lifetime PD (a measure of “Expected”
default path of the financial instrument). This has been discussed in detail in our previous blogs. On LGD,
there are not very specific directives available. The ambiguity around the subject raises a few questions,
such as:
Ÿ What is Cash Shortfall and how can it be measured?
Ÿ Can Loss Given Default (LGD) be used as a substitute for Cash Shortfall approach?
Ÿ What approaches can be taken to model or estimate LGD?
Ÿ Can regulatory estimates of LGD be used for IFRS 9 purpose?
Ÿ Can LGD developed for Basel IRB purpose be used for IFRS 9 ECL estimation? If yes, then what
adjustments would it entail?
The blog explores the limits of current knowledge (theoretical and empirical), and offers some preliminary
guidance on such questions.
Approaches to measure Cash Shortfall:
IFRS 9 defines “Cash Shortfall” as the difference between all contractual cash flows that are due to an
entity in accordance with the contract and the cash flows that the entity expects to receive. This approach,
as per IFRS9, should account for future expectations of cash flow and market related information that have
influence over the future cash flows. As accurately predicting future cash flows may be challenging, IFRS 9
does allow judgmental adjustments.
2. Direct methods are of the nature of discounted cash flow, wherein individual facilities’ cash flows are
modelled, under the assumptions of various macroeconomic scenarios and the differences from contractual
cash flows are assessed. But since these are done at an individual level, this is practically possible only for
select portfolios with small number of clients or for those facilities that are classified as Stage 3, due to
credit quality deterioration.
Indirect methods use methodologies such as vintage analysis, transition matrices etc. which compute
cash shortfall as a percentage of the outstanding based on historical numbers. LGD is not assessed
separately in such cases. These methods, while simpler to use, may not be applicable for all portfolios.
Also, auditors may want to see more statistical rigor while computing ECL.
Another Indirect method is the Simulation Based PD, LGD, and EAD, wherein movements in PD, LGD, and
EAD are simulated simultaneously. Since there are multiple recovery options, default and recovery paths
can get complicated and quite convoluted, both from an algorithm logic perspective as well as in terms of
computation power needed. The approach, however, offers a few advantages. First, the expected loss
component is inherently included in this approach as it assumes possible “default paths” and computes
expected loss directly. Secondly, the approach is applicable for financial instruments under all credit quality
assessment stages (regardless of credit deterioration). This is because the approach assumes possible
default scenario first, and then goes on to project cash flow and computation of credit losses.
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3. Since this approach requires coverage of all future potential default paths that a loan may take, it may be
appropriate to derive these paths through mathematical simulations. For these simulations, one may need to
simulate the potential paths a performing or a non-performing loan may take, and the associated estimates of cash
flows across each of those paths. A trigger for each potential path can be taken from historical behavior of
borrowers, migration from non-default states to delinquent states, and observed recovery in the event of default.
Moreover, each of these paths also depends on quantified impact of macroeconomic or loan-specific factors. Along
with defaults, estimates of cash flows are also simulated. Each of these simulation paths for a loan is then
probability weighted to arrive at an average path that a loan may take. A comparison of expected cash flow
(through simulation) and contractual cash flow is carried out to compute cash shortfall, which in turn is used to
derive Expected Credit Loss (ECL). Since historical data is the primary driver of simulations, the approach relies on
past experience significantly. Also, given that the approach requires simulation of both default events and cash flow
post default, it may be prone to multiplicative error because of potential noise in each of the simulation components
(defaults and cash flow). This is alleviated to some extent for assets under Stage 3, since the default event has
already happened and what is needed to be simulated is just the expected recovery. Thus, the need for
simulating loan path for default is eliminated.
Another Loss statistical based methodology is one wherein PD, LGD, and EAD are modularized. Their term
structures are also identified separately and then they are integrated to identify the expected loss. The
estimated LGD combined with PD and Exposure at Default (EAD) should then be discounted using
Effective Interest Rates (EIR) to estimate ECL for all possible outcomes or default paths.
Since PD has been covered in an earlier blog, we would cover aspects related to such a modularized LGD
in this blog. In order to use IRB LGD models, banks may need to make certain enhancements to IRB
models. For example, futuristic view on recovery should be added to these models. This adjustment will be
primarily required for Stage 2 and Stage 3 LGD estimation that demands computation of ECL over lifetime
of the loan. To incorporate these futuristic views, an impact of macroeconomic parameters on recovery or
loan-specific parameters should be taken into consideration. Linkage between these parameters and future
recovery cash flow should then be established. Moreover, Basel IRB requires “Downturn LGD” whereas
IFRS 9 talks of credit loss under forward-looking Macro Economic environment, which need not be
downturn environment. Please see box titled – “Some Differences between an IRB LGD model estimate
and IFRS9 LGD model estimate” on the next page.
Measurement and Estimation of LGD
LGD is usually defined as the amount of the credit that is lost by a financial institution when a borrower
defaults. Typically LGD is defined as the ratio of realized losses to the Exposure at Default (EAD). LGD
includes three types of losses:
a) The loss of principal
b) The carrying costs of non-performing loans, e.g. interest income foregone
c) Workout expenses (collections, legal, etc.).
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4. There are broadly three approaches of measuring LGDs for a financial instrument:
Ÿ Market LGD: Observed from market prices of defaulted bonds or marketable loans soon after the
actual default event.
Ÿ Implied Market LGD: Derived from risky (but not defaulted) bond prices using a theoretical asset-
pricing model. Although such methods have not yet fully migrated into the credit risk arena, they
are used for fixed income products and credit derivatives.
Ÿ Workout LGD: The set of estimated cash flows resulting from the workout and/or collections
process, properly discounted, and the estimated exposure.
Given the maturity of credit markets in most economies, Workout LGD is widely considered to be the most
flexible, transparent and logical approach to build an LGD model. Workout models have explicit structures
that represent real-world processes and the probabilities of certain recovery outcomes. LGD observed over the
course of a workout is a bit more complicated to estimate than the directly observed Market or Implied Market
LGD. Attention needs to be paid to the timing of the cash flows from the distressed asset. Measuring this timing
will impact downstream estimates of realized LGD. The cash flows should be discounted, but it is by no means
obvious which discount rate to apply. Issues related to discounting factor have been discussed extensively
during IFRS 9 drafting stage and IASB directed institutions to use Effective Interest Rate (EIR) of the financial
instrument for discounting the recovery cash flows.
There is no single Workout LGD model development strategy that can be used across banks, and in most
cases, not even in the same bank. The choice of the right model development strategy depends on various
factors such as:
l Bank-specific policies: Internal policies at each bank will play a critical role in understanding the
most suitable LGD methodology
l Region:
¡ Local regulations in several economies may have a direct impact on the way defaults are
recognized and managed
¡ The costs associated with recovery of a loan and the recovery process itself could potentially
be notably different in different regions
l The portfolio(s) within the scope of a particular LGD model:
¡ A corporate LGD model could be structured significantly different from a retail or an SME LGD
model
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Some Differences between an IRB LGD model estimate and IFRS9 LGD model estimate
There are certain differences between Basel IRB and IFRS 9 guidelines when it comes to LGD
estimation and banks that are planning to use Basel IRB LGD estimates for IFRS 9 purpose, need to
make sure appropriate adjustments are made to take care of these differences. In workout expense
estimation, Basel allows banks to take both direct and indirect expenses associated with recovery
process in credit loss estimation, whereas IFRS 9 expects banks to take only direct expenses. There are
also differences in the way the carrying cost of non-performing loans need to accounted for in the credit
loss estimates under these two guidelines. Typical LGD used for Basel Capital computation is Downturn
LGD; however in the case of IFRS 9, PIT LGDs are more appropriate. Also, one needs to bear in mind
that the LGDs are expected to be forward looking, so macroeconomic sensitivity should be ensured
while developing LGD estimates. Some of the methods like simple average based LGDs or regulatory
LGDs may not be amenable to macroeconomic adjustments that are deemed necessary under IFRS9.
Another issue is with respect to the discounting that needs to be applied to cash shortfalls, to estimate
Expected credit losses. IFRS9 is explicit in that effective interest rates (EIR) need to be used. A purist
interpretation of the rules is that the LGD models developed for IFRS9 should take into account the
effective interest rate for discounting the historical recovery cash flows in the modelling data set.
However, traditionally, contractual or penal interest rates were used in LGD modelling historically. We
feel that continuing to use contractual rates while modelling LGD would still be acceptable, as the
comment from IFRS9 is more applicable for methodologies that directly assess cash shortfall. EIR is
implicitly accounted for in loss statistics based methodologies.
5. ¡ Each portfolio / sub-portfolio within a specific bank could use differing strategies to LGD
modeling
l Finally, data availability plays one of the most crucial roles in deciding on the most effective LGD
modeling strategy
A. Statistical LGD Estimation Methodologies
There are several options among statistical LGD estimation methodologies; however, the applicability of
most of the available methodologies on portfolios is severely constrained by data availability.
a) Multivariate Linear Regression methodology is most straightforward technique for modeling
recoveries. A continuous recovery rate variable is regressed on explanatory variables.
Methodology allows for incorporating forward-looking macroeconomic factors (IFRS 9 requirement)
as explanatory variables, and accounts for the inter dependencies among some of these variables.
The major drawback of this method is that the predicted values can be outside the range and
output may need to be moderated based on expert judgment (allowed under IFRS 9).
b) Nonparametric regression trees for modeling recoveries on bank loans: The advantage of
this technique is its interpretability, since tree models resemble ‘look-up’ tables containing historical
recovery averages. Furthermore, because the predictions are given by recovery averages, they are
inevitably bounded to the unit interval.
c) Econometric methodology is specifically developed for modeling proportions, such as the
(nonlinear) fractional regression estimated using quasi-maximum likelihood methods.
d) Prediction of Loan recoveries with Neural Networks: The results indicate that the variables
which the neural network models use to derive their output coincide to a great extent with those
that are significant in parametric regression models. Out-of-sample estimates of prediction errors
suggest that neural networks may have better predictive ability than parametric regression models,
provided the number of observations is sufficiently large.
Statistical methods are preferred when recovery data is available in abundance; exhibits a relatively
smooth, homogenous structure with no obvious segmentation; and is unquestionably representative of:
Ÿ the relevant collateral being modelled;
Ÿ the Portfolio at hand;
Ÿ the recovery processes that are associated with the relevant collateral classes;
Additionally, the data must be representative of future processes. If the assumptions underlying the data
change, then data must be used more selectively, or adjusted in some way.
B. Judgmental LGD Estimation Methodologies
Banks may use pure expert judgment based LGD estimates, or rely on supervisory estimates for the LGD
values. Banks may use regulatory LGD in case there is insufficient or no data for LGD modeling. IFRS 9
has not given any specific guideline on use of regulatory LGD for estimation of ECL. If at all regulatory LGD
can be used for IFRS 9 purpose, then it may be more suitable for Stage 1, in which horizon for ECL
computation is 12-months. However, whether regulatory LGD can be used for Stage 2 or Stage 3 that
extends to lifetime of facility is unsettled. Supervisory estimates like guidance under Foundation IRB
approaches of Basel can only be benchmarks in our opinion, and the banks would have to demonstrate
applicability of these supervisory estimates. Use of external data sources may be an option in absence of
sufficient internal default history data. However, the level of adjustments that should be carried out on the
external data may remain an unknown factor, since LGD is driven by bank specific factors and contractual
terms.
C. Hybrid Methodology - Bayesian Decision Tree-based Approach
This is an approach we feel is apt for banks that have limited data but wish to develop LGD estimates
having a sound and objective basis. Decision tree-based LGD models have certain advantages in
environments where data is limited. In this approach, the recovery process is validated and all possible
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6. recovery scenarios are rendered within the model. ‘Open’ and modular structure of the Decision Tree could
be used to model any of the nodes independent of the other nodes of the Tree. The Decision Tree based
structure allows the estimation of parameters without a universal data set, i.e., separate pieces of the
fragmented information & data could be used for estimating the parameters simultaneously.
The main challenges to Decision Tree based LGD modeling with limited data include:
Ÿ Issues with data quality, quantity, relevance;
Ÿ Difficulty of finding and utilizing relevant external benchmarks – logical conservative
assumptions may need to be used in transforming available benchmarks;
Ÿ Working with expert opinion as a surrogate for data – accounting for biases that are inherent in
eliciting expert views is very critical;
Ÿ Modeling in a conservative, yet balanced manner – local regulators typically penalize model
outputs that fail to build in conservatism reasonably.
Given that most model parameters have to be estimated in the absence of sufficient data, the Bayesian
Framework is typically our recommended approach for parameter estimation under Decision Tree based
approach. The framework has proven to withstand regulatory reviews given the structural robustness of
the statistics that are the building block to the estimation methodology.
There are several advantages to the utilization of a Bayesian approach for parameter estimation:
Ÿ Stabilization of the parameter estimation process on small samples, reducing the risk of over-fitting
and the excessive influence of idiosyncratic patterns in the data;
Ÿ Integration of secondary sources of statistically-relevant information - that is not the core data - into
the parameter estimation process;
Ÿ Transparent, measurable decomposition of the separate drivers of parameter estimation;
Ÿ Quantification of conservatism within the LGD framework;
Ÿ Bayesian ‘updating’: a process whereby marginal information can dynamically update model
parameters
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7. Another perceived challenge for Decision tree based approach is development of recovery decision tree
and identification of parameters. In reality, bank-specific policies strictly regulate the recovery practices and
will help avoid unnecessary complexities in this. The following inputs from policies and procedural
guidelines can translate to logical identification of Decision Tree structure and parameters:
Ÿ Types of collateral considered against loans;
Ÿ The LTV and related characteristics of collateral that are regulated;
Ÿ Handling of cases that undergo restructuring as opposed to recovery;
Ÿ Identifying accounts or products that may qualify for a specific “recovery path”;
Ÿ Details of product-specific recovery processes, including stipulations on time periods associated
with attempted recoveries; and,
Ÿ Expectations regarding the redemption value of the associated collateral.
Forward-looking adjustment of estimated LGD
As discussed earlier, unlike IRB LGD model, for
IFRS 9 the LGD should account for forward-
looking adjustments to best estimates of expected
LGD. The estimated LGD (eLGD), derived either
statistically or judgmentally or by both (as
suggested in sections A and B above), is
inherently the first part of a two-step process. This
estimated LGD can be adjusted over a lifetime of
the facility using overlay approach given by the
Frye Jacobs methodology. Under this approach,
the impact of macroeconomic factor is linked to
PD, which in turn is linked to LGD through Frye-
Jacobs function. The approach assumes that the
asymptotic distributions of default and the loss are
co-monotonic. Thus Frye-Jacobs approach essentially produces an adjustment to an expected LGD based
on expected probability of default as implied by macroeconomic factors over the lifetime of the facility.
To summarize, in order to meet IFRS 9 requirements to compute ECL, a bank that has sufficient data
available with significant history of default may choose from a myriad of approaches. Among these choices,
the simulation based approach or the DCF based methods, although sounds promising theoretically, may
be prone to mathematical complexity and may not be feasible to implement as per bank-specific factors
discussed in this blog. Among these choices such banks may be better off with a modular LGD model
development or IRB LGD model enhancement approach with forward-looking adjustments on LGD.
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8. About
Aptivaa is a vertically focused finance and risk management consulting
and analytics firm with world-class competencies in Credit Risk, Market
Risk, Operational Risk, Basel III, IFRS-9, Risk Analytics, COSO, ALM,
Model Risk Management, ICAAP, Stress Testing, Risk Data and
Reporting. Aptivaa has emerged as a leading risk management
solutions firm having served over 100 clients across 22 countries
comprising of highly respected names in the financial services industry.
Aptivaa’s LEO suite of proprietary tools & frameworks are designed to
accelerate IFRS-9 implementation in areas such as classification, stage
evaluation, PIT-PD Calibration, Lifetime-PD, LGD, EAD and Lifetime
ECL.
UAE US UK India| | |
Feel free to send your IFRS-9 related queries to:
Sandip Mukherjee
Co-Founder and Principal Consultant
Email: sandip.mukherjee@aptivaa.com
Phone: +91- 98210- 41373
Contact: | Website: www.aptivaa.com | www.linkedin.com/company/aptivaaIFRS9.Insights@aptivaa.com