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



Year of publication 2021
Type Article in Periodical
Magazine / Source Journal of Risk Model Validation
MU Faculty or unit

Faculty of Economics and Administration

Keywords slotting approach; specialized lending; real estate; International Financial Reporting Standard 9 (IFRS 9); staging; polynomial fitting
Description 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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