FlexFinance Collective Impairment Calculator
The FlexFinance Collective Impairment Calculator is a stand-alone solution for IFRS-compliant calculation of collective impairment provisions. This is a fully-integrated application for FlexFinance IFRS customers.
The solution is based on a high-performance modelling tool that scales to a wide range of applications. It has been designed to empower business users with the ability to modify pre-delivered model templates according to their specific needs.
The calculation of collective impairment provisions has to be performed in several preliminary steps:
- Segmentation of deals to different portfolios
- Estimation of PD and LGD for each portfolio
- Transformation of PD according to loss identification period (LIP)
The FlexFinance collective impairment solution covers the steps that are necessary to calculate collective impairment. This includes the grouping of deals with similar risk characteristics and the measurement and analysis of incurred losses that haven’t yet been reported at the group level.
The solution helps bridge the gap between Basel II parameters and IFRS calculations, thanks to its advanced modelling engine.
Common Practice to Calculate Collective Impairment
‘Collective impairment’ can refer to lump sum specific provision or IBNR impairment (incurred but not reported losses).
In terms of IBNR impairment, the common practice for calculating the collective risk provisioning is to utilise risk measures like PD, LGD etc. using the following formula:
- Risk Provision = IFRS PD x Carrying amount x IFRS LGD
- PD = Probability of default
- LGD = Loss given default
Please note:
IFRS requires an ‘incurred loss’ concept. If a Basel II PD is provided/calculated, it has to be adjusted with the LIP (Loss Identification Period).
With the LIP concept introduced, risk provisioning is based on the following revised formula:
- Risk Provision = (Basel 2 (PD) x Carrying amount x adjusted LGD) x LIP
For lump sum specific provision, many financial institutes use collective assessment on non-significant financial assets. In case there is objective evidence of impairment (PD = 1), the following simplified formula is used:
- Risk Provision = 1 x Carrying amount x IFRS LGD
In this case, neither the PD nor the LIP is required (as it is individually impaired).
In order to provide necessary parameters in these formulas, several preliminary steps have to be taken:
- Segmentation of deals to different portfolios
- Estimation of PD and LGD for each portfolio
- Transformation of PD according to loss identification period (LIP) if only the Basel PD is calculated
The Solution
If the financial institution can provide all or part of the parameters used during calculation of the risk provision, the FlexFinance Collective Impairment Calculator imports these measures into the application and performs the calculation for collective impairment.
If all or some of the parameters cannot be provided, the FlexFinance Collective Impairment Calculator is capable of calculating the necessary parameters.
1) General Architecture
The FlexFinance Collective Impairment Calculator connects to the existing data sources of the financial institution. The collective impairment solution provides various techniques for parameter modelling using statistical methodology.
2) PD Estimation
In case PD cannot be delivered, the FlexFinance Collective Impairment Calculator provides templates with several PD models. Depending on the historical data available, different statistical models can be selected and applied to estimate the IFRS-PD.
The following figure describes the available templates for PD estimation
3) LGD Estimation
If LGD cannot be delivered, the FlexFinance Collective Impairment Calculator is also capable of calculating LGD based on various methods.
The following figure describes the available templates for LGD estimation.
4) Integration of LIP
Impairment provision under IFRS is only meant to cover losses that have already been incurred. In case only the Basel II PD is provided or only the Basel II PD can be estimated in the FlexFinance Collective Impairment Calculator, the loss identification period (LIP) has to be included in the parameter model.
The FlexFinance Collective Impairment Calculator incorporates several techniques for LIP calculation starting from a basic scaling technique and spilling over into more sophisticated probabilistic approaches.
