Macroeconomic Forecasting and Scenario Design for IFRS 9 and CECL

Cristian deRitis, Juan M. Licari, Gustavo Ordoñez-Sanz

All business decisions ultimately incorporate some degree of forecasting. A forecast may be as simple as the belief that historical relationships observed in the past will continue in the future, or it may be much more dynamic and sophisticated, forward-looking view. Lending decisions are essentially bets on a forecast that the obligor has a reasonably high chance of repaying its debt. Forecasts of performance are critical to the underwriting, pricing and servicing decisions of banks and other lenders. Ultimately, it is the quality of these forecasts that will determine whether an institution is profitable or risks insolvency.

Not only does forecasting make sound business sense, but regulators now require it. Both international and US accounting standards are adopting a forward-looking approach that will require lenders to forecast losses over the entire life of the loans on their books. While seemingly innocuous, both International Financial Reporting Standard Number 9 (IFRS 9) and the current expected credit loss (CECL) standard in the US have the potential to increase loss reserves significantly. In this chapter, we explore the forward-looking elements necessary to comply with

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