# What is Modelling credit risk?

## What is Modelling credit risk?

Credit risk modelling refers to the use of financial models to estimate losses a firm might suffer in the event of a borrower’s default.

What is expected credit loss model as per IFRS?

IFRS 9 requires that credit losses on financial assets are measured and recognised using the ‘expected credit loss (ECL) approach. Credit losses are the difference between the present value (PV) of all contractual cashflows and the PV of expected future cash flows. This is often referred to as the ‘cash shortfall’.

How is ECL model calculated?

ECL formula – The basic ECL formula for any asset is ECL = EAD x PD x LGD. This has to be further refined based on the specific requirements of each company, the approach taken for each asset, factors of sensitivity and discounting factors based on the estimated life of assets as required.

### How is credit loss calculated in IFRS 9?

The expected credit loss of each sub-group determined in Step 1 should be calculated by multiplying the current gross receivable balance by the loss rate. For example, the specific adjusted loss rate should be applied to the balance of each age-band for the receivables in each group.

Why do we need credit risk models?

Credit risk modelling is the best way for lenders to understand how likely a particular loan is to get repaid. In other words, it’s a tool to understand the credit risk of a borrower. This is especially important because this credit risk profile keeps changing with time and circumstances.

What is expected credit loss model?

Expected Credit Loss (ECL) is the probability-weighted estimate of credit losses (i.e., the present value of all cash shortfalls) over the expected life of a Financial Instrument.

## What is PD component for IFRS 9 and how is it calculated?

Probability of Default (PD) is an estimate of the likelihood of a default over a given time horizon. For example, a 20% PD implies that there is a 20% probability that the loan will default. (IFRS 9 makes a distinction between 12-month PD and a lifetime PD as described above).

Exposure at default (EAD) is the predicted amount of loss a bank may be exposed to when a debtor defaults on a loan. Exposure at default, loss given default, and the probability of default is used to calculate the credit risk capital of financial institutions.

What do IFRS 9 and CECL mean for credit risk modelling?

IFRS 9 and CECL Credit Risk Modelling and Validation covers a hot topic in risk management. Both IFRS 9 and CECL accounting standards require Banks to adopt a new perspective in assessing Expected Credit Losses. The book explores a wide range of models and corresponding validation procedures.

### Does IFRS 9 impairment increase credit risk?

In depth IFRS 9 impairment: significant increase in credit risk. The introduction of the expected credit loss (‘ECL’) impairment requirements in IFRS 9 Financial Instruments represents a significant change from the incurred loss requirements of IAS 39.

What is the difference between IFRS 9 and IAS 39?

It replaces IAS 39 Financial Instruments which was based on the incurred loss model whereas IFRS 9 focuses on the expected loss model that covers also future losses. In IFRS 9, the idea is to recognize 12-month loss allowance at initial recognition and lifetime loss allowance on significant increase in credit risk

What are the different types of credit risk models?

In this course, students learn how to develop credit risk models in the context of the Basel and IFRS 9 guidelines. The course extensively reviews the 3 key credit risk parameters: Probability of Default (PD), Loss Given Default (LGD), and Exposure at Default (EAD).