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Practice paper

Forecast of forecast: An analytical approach to stressed impairment forecasting

Jimmy Skoglund and Wei Chen
Journal of Risk Management in Financial Institutions, 10 (3), 238-256 (2017)
https://doi.org/10.69554/NUTW5099

Abstract

The new impairment reporting standards require banks to move from incurred loss models to sophisticated macroeconomic based expected credit loss models for current impairment estimation. While the impairment estimation is mainly focused on business as usual macroeconomic projections, there is a demand and expectation from regulators that the new impairment models should also be a foundation for the next generation stress tests. The expected credit loss models are the base for loss provisioning and hence are subject to stress testing. The use of impairment models in stressed situations of course have profound implications on banks model, calibration and validation approach. This paper proposes a forecast of forecast approach to stressed impairment estimation. The paper captures consistently the initial stressed macroeconomic development (which can, for example, be a regulatory mandated stress scenario), the bank specific assumptions about new business generated in the initial stress development and an estimation of the forward impairment forecast. After an initial motivating example of the forecast of forecast approach using a delinquency state transition model we show how an analytical and computationally tractable forecast of forecast approach can be simply implemented using only minor changes to the current impairment models calculation, especially for state transition models with no or limited state path history tracking, which covers the majority of models used by banks in practice.

Keywords: credit risk; macroeconomics; impairment forecasting forecast of forecast; IFRS 9; CECL

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Author's Biography

Jimmy Skoglund is Principal Product Manager at SAS. He has more than 15 years’ experience developing and implementing risk methodologies, both at SAS and previously at banks. Jimmy has worked in various areas of risk management, including market, credit and liquidity risk. He holds a PhD from Stockholm School of Economics and is a regular contributor to publications in risk and finance journals.

Wei Chen is a Director of Stress Testing Solution at SAS Institute Inc. He has more than 15 years’ industry experience in risk analytics and technology for both banking and insurance. At SAS he has managed the research and development of solutions and business consulting in market, credit and liquidity risk management. Wei has published frequently in risk journals. He received his PhD, his primary research area being in financial econometric modelling, from the University of Iowa. He is a certified Financial Risk Manager (FRM).

Citation

Skoglund, Jimmy and Chen, Wei (2017, August 1). Forecast of forecast: An analytical approach to stressed impairment forecasting. In the Journal of Risk Management in Financial Institutions, Volume 10, Issue 3. https://doi.org/10.69554/NUTW5099.

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cover image, Journal of Risk Management in Financial Institutions
Journal of Risk Management in Financial Institutions
Volume 10 / Issue 3
© Henry Stewart
Publications LLP

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