Expected Credit Loss Impairment: Early Recognition vs. Income Volatility

• Author / Creator

  Ewanchuk, Logan

• Recently, a new accounting standard was established, namely the International Financial Reporting Standard 9, requiring banks to build provisions using forward-looking expected loss models. When there is a significant increase in credit risk of a loan, additional provisions must be charged to the income statement. Banks need to set a threshold for each loan, defining what such a significant increase in credit risk constitutes. A low threshold allows banks to recognize credit risk early, but leads to greater income volatility. By introducing a statistical framework, this trade-off between early recognition of credit risk and avoidance of excessive income volatility is modelled. We analyze the resulting optimization problem for various models in both continuous-time and discrete-time settings, relate it to the banking stress test of the European Union, and illustrate it using historical default data by Standard and Poor's.

• Subjects / Keywords

  • risk modelling
  • income volatility
  • expected credit loss
  • IFRS 9
  • statistical optimization
  • credit risk

• Graduation date

  Fall 2019

• Type of Item

  Thesis

• Degree

  Master of Science

• DOI

  https://doi.org/10.7939/r3-kd8n-t720

• License

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