CCAR Stress Testing and Its Implications for Risk Modeling
Climate risk is increasingly a discussion topic amongst financial market participants and regulators. And yet, there are still many questions about its provenance and impacts, and applications to best practices in the financial sectors. We will address these questions and more in an interactive, informative format.
We examine past histories of recessions and crises to identify hidden vulnerabilities and weak links in the economy and financial system.
Measuring and Managing the Impact of IFRS 9 and CECL Requirements on Dynamics in Allowance, Earnings, and Bank Capital
This paper explores how CECL and IFRS 9 might impact loss allowance, earnings, and capital dynamics, and how these dynamics might affect credit portfolio management.
Using a long history of public firm defaults from Moody's Investor Services and Moody's Analytics, this study illustrates a validation approach for jointly testing the impact of PD and correlation upon model performance. We construct predicted default distributions using a variety of PD and correlation inputs and examine how the predicted distribution compares with the realized distribution. The comparison is done by looking at the percentile of realized defaults with respect to the predicted default distribution. We compare the performance of two typical portfolio parameterizations: (1) a through-the-cycle style parameterization using agency ratings-based long-term average default rates and Basel II correlations; and (2) a point-in-time style parameterization using public EDF credit measure, and Moody's Analytics Global Correlation Model (GCorr™). Results demonstrate that a through-the-cycle style parameterization results in a less conservative view of economic capital and substantial serial correlation in capital estimates. Results also show that when point-in-time measures are used, the tested economic capital model produces consistent and conservative economic capital estimates over time. A version of this paper appears in the Journal of Risk Model Validation, March 2013.
Effective risk assessment approaches to project finance must reflect a true understanding of complex issues. These assessments include the macroeconomic context, which provides an early indication of the potential risks and returns of infrastructure investments.
In this presentation, our experts Emil Lopez and Jing Zhang, introduce some key CECL quantification methodologies and enhancements that can be made to existing approaches to make them CECL compliant.
In this presentation, our experts Emil Lopez and Jing Zhang, introduce some key CECL quantification methodologies and enhancements that can be made to existing approaches to make them CECL-compliant.
IFRS 9 materially changes how institutions set aside loss allowance. With allowances flowing into earnings, the new rules can have dramatic effects on earnings volatility. In this paper, we propose general methodologies to measure and manage credit earnings volatility of a loan portfolio under IFRS 9. We walk through IFRS 9 rules and the different mechanisms that it interacts with which flow into earnings dynamics. We demonstrate that earnings will be impacted significantly by credit migration under IFRS 9. In addition, the increased sensitivity to migration will be further compounded by the impact of correlation and concentration. We propose a modeling framework that measures portfolio credit earnings volatility and discuss several metrics that can be used to better manage earnings risk.
Managing Earnings Volatility and Uncertainty in the Supply and Demand for Regulatory Capital: The Impact of IFRS 9
This paper presents a novel modeling approach that allows for better management of the interplay between supply and demand dynamics for regulatory capital, combining an economic framework with regulatory capital and new loss recognition rules. The framework is particularly relevant in understanding the extent to which IFRS 9 can lead to more aggressive provisioning, which feeds into earnings volatility. Our approach provides guidance on how organizations can better manage their capital buffer, considering investment concentration, its impact on earnings volatility, and the relationship with regulatory capital requirements. Imperative to portfolio management, the framework recognizes the likelihood of a capital shortfall being significantly impacted by portfolio asset class, geography, industry, and name concentration, as extreme fluctuations in capital supply and demand occur more often for institutions holding more concentrated portfolios. Finally, we discuss integrated investment and strategic decision measures that account for the full spectrum of economic risks and interactions with regulatory and accounting rules, as well as instruments' contribution to earnings volatility and capital surplus dynamics.
The answer is a definitive “Yes,” suggesting increased project finance investment could become an important tool for addressing sluggish growth concerns brought about by the Great Recession. Empirical results, based on a comprehensive and unique project finance loan database not previously available, show that increasing project finance by one percentage point of GDP could increase real GDP growth per capita by 6 to 10 percent, with growth effects higher for upper-middle income and advanced economies. In other words, in these countries, if GDP per capita is growing at three percent annually, the boost provided by project finance could deliver cumulative, additional growth as high as two percent during the next five years. These results suggest that proposals for stimulating economic growth and productivity via increased project finance merit careful consideration. In contrast, in low-income countries, project finance appears to have less of an impact, possibly owing to deficiencies and weaknesses in financial systems and regulatory frameworks. By addressing these deficiencies, less developed countries could unleash increased growth and productivity.