![]() The PIT transition matrices can be used to determine rating transitions in various states of the economy. Convert rating transition matrices from TTC to PIT: In this step, the forward-looking information is used to convert TTC rating transition matrices to point-in-time (PIT) rating transition matrices.Obtain Z-factor forecasts using macro-economic projections.Regress historical Z-factors on (global or local) macro-economic variables.Derive historical Z-factors from (global or local) historical default rates.The approach consists of the following sub-steps: Essentially, a relationship is determined between historical default rates and specific macroeconomic variables. The forward-looking methodology in the CRS is based on a ‘Z-factor approach’, where the Z-factor represents the state of the macroeconomic environment. In the CRS, the state of the economy is incorporated in the PD by applying a forward-looking methodology. Apply forward-looking methodology: IFRS 9 requires the state of the economy to be reflected in the ECL.The TTC rating transition matrices can be constructed using e.g., historical default data provided by the client or external rating agencies. A transition matrix specifies the probability to go from a specified rating to another rating in one year time. Determine TTC rating transition matrices: To be able to calculate PDs for all possible maturities, an approach based on rating transition matrices is applied.The PIT PDs are determined in the following steps: The TTC rating migration matrices represent the long-term average annual transition PDs, while the PIT rating migration matrices are annual transition PDs adjusted to the current (expected) state of the economy. This is done by transforming Through-the-Cycle (TTC) rating migration matrices into PIT rating migration matrices. The purpose of this module is to determine forward-looking Point-in-Time (PIT) PDs for all counterparties. Probability of defaultįor each projected month, the PD is derived from the PD term structure that is relevant for the portfolio as well as the economic scenario. The methodology that is applied for each of the components is described below. This component-based setup of the CRS allows for customizable and easy to implement approach. In the component approach, projections of PDs, EADs and LGDs are constructed separately. Moreover, the solution allocates assets to one of the three IFRS 9 stages. Besides this, the CRS contains a customizable module for scenario-based Forward-Looking Information (FLI). The separate components are then combined into ECL provisions which can be utilized for IFRS 9 accounting purposes. The CRS consists of multiple components and underlying models that are able to calculate each of these ingredients separately. The overall ECL calculation is performed as follows and illustrated by the diagram below: Discount factors according to IFRS 9 are based on the effective interest rate. Discount Factor (DF): The expected loss per period is discounted to present value terms using discount factors.The LGD differs with the level of collateral, guarantees and subordination associated with the financial instrument. Loss Given Default (LGD): The percentage of EAD that is expected to be lost in case of default. ![]() Exposure at Default (EAD): The exposure remaining until maturity of the contract based on current exposure, contractual, expected redemptions and future drawings on remaining commitments.A lifetime PD can be split into marginal PDs which represent the probability of default in a certain period. the probability of defaulting before the maturity of the contract. the probability of defaulting between now and one year, or a lifetime PD, i.e. Probability of Default (PD): The probability that a counterparty will default at a certain point in time.In this article, we will elaborate on the methodology of the ECL calculations that take place in the CRS.Īn industry best-practice approach for ECL calculations requires four main ingredients: The CRS was designed specifically to overcome the difficulties that our clients face in their IFRS 9 provisioning. The Credit Risk Suite is a calculation engine that determines transaction-level IFRS 9 compliant provisions for credit losses. Using our hands-on experience and over two decades of credit risk expertise of our consultants, Zanders developed the Credit Risk Suite. Specifically, the difficulties that the incorporation of forward-looking information in the loss estimate introduces should not be underestimated. Although the IFRS 9 standards are principle-based and simple, the design and implementation can be challenging. The IFRS 9 accounting standard has been effective since 2018 and affects both financial institutions and corporates. Credit Risk Suite – Expected Credit Losses Methodology article Introduction
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