International Financial Reporting Standard 9 expected credit loss estimation: advanced models for estimating portfolio loss and weighting scenario losses

Bill Huajian Yang, Biao Wu, Kaijie Cui, Zunwei Du and Glenn Fei

Journal of Risk Model Validation

Abstract: The estimation of portfolio expected credit loss is required for International Financial Reporting Standard 9 (IFRS9) regulatory purposes. This starts with the estimation of scenario loss at loan level, which is then aggregated and summed up by scenario probability weights to obtain the portfolio expected loss. This estimated loss can vary significantly depending on the levels of loss severity generated by the IFSR9 models and the probability weights chosen. There is a need for a quantitative approach to determine the weights of scenario losses. In this paper, we propose a model to estimate the expected portfolio losses brought about by recession risk and a quantitative approach to determine the scenario weights. The model and approach are validated by an empirical example, where we stress the portfolio expected loss using recession risk and calculate the scenario weights accordingly.

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