Credit risk term-structures for lifetime impairment forecasting: A practical guide

Abstract

In this paper, we provide an overview of the credit model approaches for lifetime impairment models. The main focus is on the models for credit risk term-structures, which are a particularly important component that banks are currently struggling with. We also, however, discuss briefly the different model approaches for loss given default and exposure. The aim of this paper is to provide a (relatively) non-technical overview of modelling approaches to aid in understanding different models properties and consequently in model selection. For those that require more details for actual model implementation we provide references to the literature. We also discuss how to decompose the period to period impairment change into its components for change explanation. An impairment decomposition is quite straightforward and can be done using incremental change of the components, or, a log-linearisation. The benefit of the log-linearisation is its order independence.