IFRS 9 and CECL Credit Risk Modelling and Validation

A Practical Guide with Examples Worked in R and SAS

Tiziano Bellini

• Publisher: Academic Press
• Year: 2019
• ISBN:
  9780128149416
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

IFRS 9 and CECL Credit Risk Modelling and Validation covers a hot topic in risk management. Both IFRS 9 and CECL accounting standards require Banks to adopt a new perspective in assessing Expected Credit Losses. The book explores a wide range of models and corresponding validation procedures. The most traditional regression analyses pave the way to more innovative methods like machine learning, survival analysis, and competing risk modelling. Special attention is then devoted to scarce data and low default portfolios. A practical approach inspires the learning journey. In each section the theoretical dissertation is accompanied by Examples and Case Studies worked in R and SAS, the most widely used software packages used by practitioners in Credit Risk Management.

• Offers a broad survey that explains which models work best for mortgage, small business, cards, commercial real estate, commercial loans and other credit products
• Concentrates on specific aspects of the modelling process by focusing on lifetime estimates
• Provides an hands-on approach to enable readers to perform model development, validation and audit of credit risk models

Chapter 1

Introduction to Expected Credit Loss Modelling and Validation

Abstract

As a response to incurred losses criticisms, both the International Accounting Standard Board (IASB) and Financial Accounting Standard Board (FASB) worked to redesign accounting standards towards an expected credit loss paradigm. The aim was to anticipate loss recognition by avoiding issues experienced—in particular—during the 2007–2009 financial crisis. Starting from an initial joint effort for a unique solution, IASB and FASB agreed on common principles, but then issued two separated standards. IASB's International Financial Reporting Standard number 9 (IFRS 9), issued in 2014, relies on a three-bucket classification, where one-year or lifetime expected credit losses are computed. On the contrary, FASB's Current Expected Credit Loss (CECL) accounting standard update 2016–13 (topic 326: credit losses) follows a lifetime perspective as a general rule. IFRS 9 and CECL are separately introduced in Sections 1.2 and 1.3 to point out their similarities and differences. Then the focus is on the link connecting expected credit loss estimates and capital requirements as detailed in Section 1.4. As a final step, a book overview is provided in Section 1.5 as a guide for the reader willing to grasp on overview of the entire expected credit loss modelling and validation journey.

Keywords

Current expected credit loss (CECL); expected loss (EL); International financial reporting standard number 9 (IFRS 9); point-in-time (PIT) estimate; risk weighted assets (RWAs); through the cycle (TTC) estimate; unexpected loss (UL)

As a response to incurred losses criticisms, both the International Accounting Standard Board (IASB) and Financial Accounting Standard Board (FASB) worked to redesign accounting standards towards an expected credit loss paradigm. The aim was to anticipate loss recognition by avoiding issues experienced—in particular—during the 2007–2009 financial crisis.

Starting from an initial joint effort for a unique solution, IASB and FASB agreed on common principles, but then issued two separated standards. IASB's International Financial Reporting Standard number 9 (IFRS 9), issued in 2014, relies on a three-bucket classification, where one-year or lifetime expected credit losses are computed. On the contrary, FASB's Current Expected Credit Loss (CECL) accounting standard update 2016–13 (topic 326: credit losses) follows a lifetime perspective as a general rule.

IFRS 9 and CECL are separately introduced in Sections 1.2 and 1.3 to point out their similarities and differences. Then the focus is on the link connecting expected credit loss estimates and capital requirements, as detailed in Section 1.4. As a final step, a book overview is provided in Section 1.5 as a guide f...