Integrating Credit Risk within the ALM Framework

Alina Preger and Sophie He

Traditionally, banks used to monitor and manage their credit risk and interest rate risk in the banking book (IRRBB) separately. On the one hand, the credit risk management team would calculate capital requirements, impairments and provisions without considering the impact of interest rate scenarios and ALM cashflow modelling. On the other hand, the IRRBB management team would project repricing cashflows and hedge net interest income (NII) and economic value (EV) sensitivities based on a contractual or behaviourally adjusted representation (prepayment, attrition, stickiness, etc), without considering the impact of default flows and credit losses, and often with simplified non-performing loan (NPL) modelling.

The introduction of new IFRS 9 accounting principles stressed the need for a stronger integration between credit risk and ALM, both in terms of cashflow modelling and of impact of interest rates scenarios on credit risk parameters. In fact, the IFRS 9 regulation, in force since January 1, 2018, moved away from the previous IAS 39’s incurred loss model based on the occurrence of specific events, and introduced a new expected (lifetime) credit loss model to anticipate the

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