PD is commonly used in risk management with the concept of “through the cycle (TTC)”. It is conceptually different to requirements in IFRS 9 which requires looking forward over the lifetime of a financial instrument while considering economic scenarios.
Different components need to be selected, depending on whether a customer decides (Variant A) to use the transfer of today's PD from capital requirements In FlexFinance, one can decide which of the following variants shall be used:
- Variant A, in which a PD known from the implementation of the capital guidelines is transferred to a PD (PIT)
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- Variant B
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- , in which the available historical scoring information is evaluated in combination with macroeconomic parameters
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- for the direct derivation of a PD (PIT)
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Depending on the variant selected, different components are used:
- Variant A:
- Component
- "Macroeconomic Factor
- Component "Transfer PD (TTC) to PD (PIT)
- ".
- Variant B: Component “Derive
- Component "PD (PIT) Roll Rate of DpD".
- Component "PD (PIT)
- Rating/Scoring Migration Analysis".
Variant A - Transfer PD (TTC) to PD (PIT)
This variant has to be applied if a customer decides to transfer an existing PD (TTC) to a PD (PIT) applying macroeconomic factors.
It requires a PD (TTC) as a starting point that can be calculated in another model or can be imported from an external source.
Component "Transfer PD (TTC) to PD (PIT)"
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The target of this component is to use the existing PD (TTC) by applying macroeconomic factors. By adjustment via macroeconomic factors, the economic scenario in a specific period is considered. PD (PIT) for each period in the future is calculated by applying PD (TTC) with a correlation between derivation of the default rate and the projected macroeconomic parameters of that period.
The output The output of this component is the PD (PIT) for time periods in the future. This output will be considered as input in the components “PwECL Simulation” and “PwECL Calculation”.
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- Correlation between derivation of the default rate and macroeconomic parameters (output from component “Macroeconomic Factor”).
- PD (TTC) at segment/portfolio or at deal level.
- Estimation of macroeconomic parameters for future periods. If an estimation of macroeconomic parameters for future periods is not available, the moving average method will be applied for forecasting macroeconomic parameters (e.g. baseline/normal). Shift scenarios (such as -25 bps or 25 bps) will be configured for other scenarios (e.g. upside, downside).
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Component "Macroeconomic Factor"
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The component studies the correlation between default patterns in past periods with the relevant macroeconomic parameters available in those periods. By applying the regression method, a correlation can be set up between the derivation of the default rate for a specific period compared with the average default rate over the periods and underlying macroeconomic parameters. For each scenario, the bank needs to input a maximum of 5 macroeconomic parameters for a timeline. In addition, internal or external historical default rates (or accounting data) in past periods/years (by segment/portfolio) need to be provided.
Variant B - PD (PIT)
Component "PD (PIT) Roll Rate of DpD"
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- deal ID
- exposure
- days past due
- values of macroeconomic parameters
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Component “PD (PIT) Rating/Scoring Migration Analysis”
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