A methodology to measure the impacts of scenarios through expected credit losses

Mahmood Alaghmandan; Meghal Arora; Olga Streltchenko

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Need to know

Existing IFRS 9 / CECL provisioning infrastructure can be repurposed directly to quantify the impact of macroeconomic, climate, or other scenarios, without building separate stress-testing systems.
The framework translates any scenario narrative into probability-of-default adjustments, which flow through the standard ECL formula to produce a scenario-adjusted loss estimate directly comparable to the baseline.
Applying scenario adjustments at the level of standardized exposure groupings captures the heterogeneity of scenario impacts across a portfolio while keeping the number of risk factors manageable.
The methodology is scenario-agnostic and applies equally to climate transition, physical risk, or conventional macroeconomic stress scenarios.

Abstract

In this paper, we present a methodology for measuring the impact of scenarios on the expected losses of exposures by leveraging the existing provisioning infrastructure within financial institutions, where scenario effects are captured through changes in probabilities of default. This methodology formed the theoretical foundation of the 2024 standardized climate scenario exercise conducted by the Office of the Superintendent of Financial Institutions Canada and Québec’s Autorité des Marchés Financiers. We also describe how to design and implement a scenario test, where risk drivers are given for standardized groupings of exposures and the groupings are defined based on common features of the exposures.

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