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Book Review: IFRS 9 and CECL Credit Risk Modelling and Validation - A Practical Guide With Examples in R and SAS

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363 views2 pages

Book Review: IFRS 9 and CECL Credit Risk Modelling and Validation - A Practical Guide With Examples in R and SAS

review

Uploaded by

neodvx
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Prajnan, Vol. XLVIII, No.

4, 2019-20 © 2019-20, NIBM, Pune

Book Review

IFRS 9 and CECL Credit Risk Modelling and Validation –


A Practical Guide with Examples in R and SAS

Tiziano Bellini

Academic Press, Elsevier, London, UK, 2019, 316 pp, £145.00

Reviewed by Dr Arindam Bandyopadhyay, Editor, Prajnan, National Institute


of Bank Management, Pune.

It is critical to appropriately determine how, when and in what amount should


the effects of increase in credit risk must be recognized is a matter of priority
for all stakeholders in the banking industry. The International Financial
Reporting Standards 9 (IFRS9) rule has introduced fundamental changes in
credit impairment standards since it suggests accounting practice should
recognize expected loss based provision in the balance sheet instead of incurred
loss based provisioning. Under the new accounting system, banks as well as
NBFCs will have to adopt a new perspective in estimating Expected Credit
Loss (ECL) for loan provisioning. Internal credit risk models need to be
developed, loan cash flows need to be mapped diligently to appropriately
measure expected loss. The book written by Tiziano Bellini explores wide range
of modelling techniques available to develop credit risk models for this purpose.
It discusses Generalized Linear Regression Models as well as Regression Trees
and Machine Learning Techniques and their applications in credit risk
assessment.

The book covers many interesting discussions like estimation requirements


for stage 1 twelve month Probability of Default (PD) Vs stage 2 lifetime PD.
The author has suitably explained the difference between IFRS9 expected loss
provisioning and prudential Basel provisioning. To address the lack of incurred
loss model under IAS 39, the author stresses that the new IFRS9 accounting
model advocates for forward looking expected credit loss based provisioning.
Hence, there is an improvement in provisioning methodology, from incurred
loss based to expected loss based provisioning approach. The author also
compares International Accounting Standards Board (IASB) introduced ECL
(July 2014) Vs. Financial Accounting Standards Board (FASB) prescribed
Current Expected Credit Losses (CECL, June 2016) approach and pinpoint
their similarities. The allowances of credit losses by IASB are based on three
stages with 12 months ECL for stage 1 and lifetime losses (based on PD for
370 Prajnan

entire time horizon of the loan and yearly LGD) for stage 2 and stage 3 (based
on internal LGD estimates). Under IFRS 9, account level provisioning shifts to
stage 2 after borrower shows significant increase in credit risk since initial
recognition. The book explains the difference in modelling techniques in these
stages. The FASB CECL standard focuses on estimation of expected loss over
the life of the loans. It concentrates on specific aspects of the modelling process
by focusing on lifetime estimates under FASB system. Unlike FASB, IFRS 9
requires one credit loss approach based on probability weighted scenarios for
all financial assets. The book also highlights estimation methods for low default
portfolios and scarce data model validation procedures.

Tiziano Bellini could have brought more discussion about the comparison of
parameter calculation across different drivers of credit risk, e.g. of Exposure
at Default (EAD) and Loss Given Default (LGD). Many internal approaches
with numerical illustrations could have been more insightful. Similarly,
discussion LGD methodologies to be adopted by banks might have improved
the understanding of readers/students who are new in this domain. It doesn't
provide a comprehensive calculation example of ECL across multiple years,
where marginal PDs, lifetime PD, and marginal ECLs would be shown, because
there are always some simplifications. So a little more discussions about a PD
term structure on a life time path, how it is affected by economic cycle, as well
as providing examples showing scenario based ECL calculation. The illustration
on techniques to estimate forward looking PD by incorporating macroeconomic
scenarios would have further enriched the book.

The book comprehensively covers many important aspects related to ECL


modelling (e.g. loss rate methods, vintage analysis, PD, LGD, EAD methods,
data preparation, validation techniques, etc.) and provides hands on training
in SAS and R. It gives us a broad survey that demonstrates which models will
work best for various categories of portfolios: Mortgage Loans, Small Business,
Commercial Real Estate, Credit Card as well as Corporate Loans. Many case
studies and numerical applications in R and SAS platform provide great insight
about several technique in the measurement of credit risk. The reader will
gain lot of insights on various approaches of measuring probability of default
and obtain forward looking ECL estimates. The methods discussed in this
book can be used as a good benchmark to implement and validate the expected
credit loss measures.

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