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Efficient credit portfolios under IFRS 9

Rui Pedro Gonçalves Brito and Pedro Maria Corte Real Alarcão Judice
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Rui Pedro Gonçalves Brito: University of Coimbra, Centre for Business and Economics Research, CeBER and Faculty of Economic
Pedro Maria Corte Real Alarcão Judice: ISCTE Business Research Unit

No 2021-07, CeBER Working Papers from Centre for Business and Economics Research (CeBER), University of Coimbra

Abstract: In this paper, we devise a forward-looking methodology to determine efficient credit portfolios under the IFRS 9 framework. We define and implement a credit loss model based on prospective point-in-time probabilities of default. We determine these probabilities of default and the credits’ stage allocation through a credit stochastic simulation. This simulation is based on the estimation of transition matrices. Using data from 1981 to 2019, in a non-homogeneous Markov chain setting, we estimate transition matrices conditional on the global real gross domestic product growth. This allows considering the effects of the economic cycle, which are of great importance in bank management. Finally, we develop a robust optimization model that allows the bank manager to analyze the tradeoff between the annual average portfolio income and the corresponding portfolio volatility. According to the proposed bi-objective model, we compute the efficient credit portfolios constructed based on 10-year maturity credits. We compare their structure to those generated by the IAS 39 and CECL accounting frameworks. The results indicate that the IFRS 9 and CECL frameworks generate efficient credit portfolios whose structure penalizes riskier-rated credits. In turn, the riskier efficient credit portfolios under the IAS 39 framework concentrate entirely on speculative-grade credits. This pattern is also encountered in efficient credit portfolios constructed based on credits with different maturities, namely 5 and 15 years. Moreover, the longer the maturity of the credits that enter into the composition of the efficient portfolios, the more the speculative-grade credits tend to be penalized.

Keywords: IFRS 9; IAS 39; CECL; credit risk; transition matrices; stochastic simulation. (search for similar items in EconPapers)
JEL-codes: C44 C50 C61 C63 G11 G17 G24 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2021-07
New Economics Papers: this item is included in nep-acc, nep-ore and nep-rmg
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