Development of an Impairment Point in Time Probability of Default Model for Revolving Retail Credit Products: South African Case Study

Douw Gerbrand Breed, Niel van Jaarsveld, Carsten Gerken, Tanja Verster and Helgard Raubenheimer
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Douw Gerbrand Breed: Centre for Business Mathematics and Informatics, North-West University, Private Bag X6001, Potchefstroom 2520, South Africa
Niel van Jaarsveld: Independent Researcher, 20 Timbavati, St. Christopher Rd., St. Andrews, Bedfordview 2007, South Africa
Carsten Gerken: Independent Researcher, Hartmannsweilerstr. 55, 65933 Frankfurt am Main, Germany
Tanja Verster: Centre for Business Mathematics and Informatics, North-West University, Private Bag X6001, Potchefstroom 2520, South Africa
Helgard Raubenheimer: Centre for Business Mathematics and Informatics, North-West University, Private Bag X6001, Potchefstroom 2520, South Africa

Risks, 2021, vol. 9, issue 11, 1-22

Abstract: A new methodology to derive IFRS 9 PiT PDs is proposed. The methodology first derives a PiT term structure with accompanying segmented term structures. Secondly, the calibration of credit scores using the Lorenz curve approach is used to create account-specific PD term structures. The PiT term structures are derived by using empirical information based on the most recent default information and account risk characteristics prior to default. Different PiT PD term structures are developed to capture the structurally different default risk patterns for different pools of accounts using segmentation. To quantify what a materially different term structure constitutes, three tests are proposed. Account specific PiT PDs are derived through the Lorenz curve calibration using the latest default experience and credit scores. The proposed methodology is illustrated on an actual dataset, using a revolving retail credit portfolio from a South African bank. The main advantages of the proposed methodology include the use of well-understood methods (e.g., Lorenz curve calibration, scorecards, term structure modelling) in the banking industry. Further, the inclusion of re-default events in the proposed IFRS 9 PD methodology will simplify the development of the accompanying IFRS 9 LGD model due to the reduced complexity for the modelling of cure cases. Moreover, attrition effects are naturally included in the PD term structures and no longer require a separate model. Lastly, the PD term structure is based on months since observation, and therefore the arrears cycle could be investigated as a possible segmentation.

Keywords: probability of default; point in time; IFRS 9; expected credit loss (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2021
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