Journal of Risk Model Validation

Validation nightmare: the slotting approach under International Financial Reporting Standard 9

Lukasz Prorokowski, Oleg Deev and Jena-Daniel Guigou

  • Correspondence between the slotting scores and PDs is possible to satisfy the IFRS 9 rules on denotching and staging.
  • For the PD mapping methodology, both the target RWA and Expected Loss should be considered.
  • Since there are distinct slotting categories, the sequential process should be solved for each slotting category.
  • For the PD mapping methodology, the exposures should be differentiated by the maturity regulatory-prescribed thresholds.

This paper makes an important contribution to the practice of validation by focusing on an under-researched area of the slotting approach to real estate specialized lending under the International Financial Reporting Standard 9 (IFRS 9) framework. The paper introduces the concept of mapping the probability of default estimates to the slotting scores. A sequential process for deriving the correspondence between the slotting scores and probabilities of default of a particular obligor is proposed as a solution to adapting the slotting approach to the IFRS 9 rules. This solution is especially useful for capturing the increase in credit risk under the IFRS 9 rules using denotching and staging processes. All in all, this paper addresses the research questions of whether and how a slotting model can be used for IFRS 9 compliance purposes. In addition to the core aim of the paper, which is the provision of a probability of default mapping solution under the IFRS 9 framework, we also explain the methodology of a slotting model, discussing specific modeling choices for the real estate slotting approach aligned to the relevant regulatory framework. In doing so, we provide an example of a slotting model that can be used by practitioners as a challenger model during the validation exercise.

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