Emergence of shocks to the financial system has been more frequent in recent years. The global pandemic and its knock-on impact on the real economy and in turn, on the financial sector has further exacerbated this risk both, in terms of magnitude and duration. Recently the RBI Governor Shaktikanta Das articulated that “An effective early warning system and forward-looking stress testing framework should be an integral part of the risk management framework of the banks. Banks should be able to pick-up incipient signals of stress faced by their borrowers, and take proactive remedial action...” For the financial sector, greater focus on identifying the early warning signals and initiating a corrective action plan has emerged to be the need of the hour!
It is in this context that we propose an econometric model for macro stress testing to facilitate banks to assess their NPA cycles and IFRS impairment estimates. The overlay of macroeconomic cycles is critical in estimating the probability of default (PD), credit losses, etc.
- Facilitate forward-looking and probability-weighted aspects of IFRS impairment calculation using dynamic macroeconomic forecasts
- The constituents of the model will be a function of the economic scenario, portfolio complexity, sector specifications, etc.