Point-in-time loss-given default rates and exposures at default models for IFRS 9/CECL and stress testing

Gaurav Chawla, Lawrence R. Forest Jr. and Scott D. Aguais

Journal of Risk Management in Financial Institutions, 2016, vol. 9, issue 3, 249-263

Abstract: In contrast with Basel II rules, which call for the use of through-the-cycle (TTC) probabilities of default (PDs) and downturn (DT) loss-given default rates (LGDs) and exposures at default (EADs), the regulatory stress tests and the new IFRS 9 and proposed Current Expected Credit Loss (CECL) accounting standards require institutions to use point-in-time (PIT) projections of PDs, LGDs and EADs. By accounting for the current state of the credit cycle, PIT measures track closely the variations in default and loss rates over time. In past publications the authors have described the derivation of industry-region credit-cycle indices (CCIs) and the use of those indices in converting legacy wholesale credit PD models, which typically understate cyclical variations, into fully PIT ones. This paper extends that framework to cover estimation of PIT LGDs and EADs for wholesale exposures. The authors offer options for the formulation of such models and discuss their experience in building PIT LGD and EAD models, and show that, by accounting for the probabilistic evolution over time in industry-region CCIs, one can derive joint, PD, LGD and EAD scenarios for use in the regulatory stress tests or in estimating the term structures of expected credit losses (ECLs) as needed for IFRS 9/CECL.

Keywords: point-in-time (PIT); through-the-cycle (TTC); loss-given default (LGD); exposure at default (EAD); IFRS 9/CECL; expected credit loss (ECL); stress testing (search for similar items in EconPapers)
JEL-codes: E5 G2 (search for similar items in EconPapers)
Date: 2016
References: Add references at CitEc
Citations: View citations in EconPapers (1)

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