A Methodology to Measure Impacts of Scenarios Through Expected Credit Losses

TL;DR

This paper introduces a methodology for quantifying how different scenarios affect expected credit losses in financial exposures by using existing provisioning systems and scenario testing based on exposure features.

Contribution

It provides a novel framework for scenario impact measurement on credit losses, applicable within current provisioning infrastructures and supporting standardized climate scenario assessments.

Findings

Methodology effectively captures scenario impacts on expected losses.

Framework applied in 2024 climate scenario exercise in Canada and Quebec.

Supports standardized scenario testing for financial risk management.

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. We then 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. The methodology presented served as a theoretical foundation for the standardized climate scenario exercise conducted in 2024 by the Office of the Superintendent of Financial Institutions of Canada and Quebec's Autorite des Marches Financiers.