38. Sound credit risk methodologies should consider different potential scenarios and should not …

Sound credit risk methodologies should consider different potential scenarios and should not rely purely on subjective, biased or overly optimistic considerations. Credit institutions should develop and document their processes to generate relevant scenarios to be used in the estimation of ECL. In particular:

• a. credit institutions should demonstrate and document how ECL estimates would alter with changes in scenarios, including changes to relevant external conditions that may impact ECL estimates or components of the ECL calculation (such as PD and LGD parameters);
• b. credit institutions should have a documented process for determining the time horizon of the scenarios and, if relevant, how ECL is estimated for exposures whose lives exceed the period covered by the economic forecast(s) used;
• c. scenarios may be internally developed or outsourced. For internally developed scenarios, credit institutions should have a variety of experts, such as risk experts, economists, business managers and senior management, assisting in the selection of scenarios that are relevant to the credit institutions’ credit risk exposure profile. For outsourced scenarios, credit institutions should ensure that the external provider tailors the scenarios to reflect the credit institutions’ business and credit risk exposure profile, as credit institutions remain responsible for those scenarios;
• d. backtesting should be performed to ensure that the most relevant economic factors that affect collectability and credit risk are being considered and incorporated into ECL estimates; and
• e. where market indicators (such as credit default swaps (‘CDS’) spreads) are available, senior management may consider them to be a valid benchmark against which to check the consistency of its own judgements.

1. Overview

1.1 References

1.2 Identified Requirements

1.3 Related Standards

2. Identified Requirements

3. Related Standards

• EBA - Published by the European Banking Authority at https://www.eba.europa.eu/