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ICAAP: Credit Risk: Stress Test: How to Determine Expected Classification Rates

In this post we will consider how to derive expected classification rates for “current” customers of a loan portfolio. This is used to calculate the expected “current” customers who will be classified within the next period, which will in turn be used in the quantification process of credit risk under the Internal Capital Adequacy and Assessment Process (ICAAP).

How to determine expected classification rate

Expected classification is calculated using the following steps:

  • Outstanding exposure at the start of the period for all customers
  • Outstanding exposure (adjusted) at the end of the period for classified customers
  • Outstanding exposure at the end of the period for ‘current’ customers
  • Percentage classified (end of period): This is the percentage of total outstanding at the start of the period, classified at the end of period (adjusting for any additional exposure taken during period)
  • Expected classification: This is the percentage classified calculated applied to outstanding exposure at the end of the period for ‘current’ customers

We have reviewed the step-by-step procedure for deriving expected classification rates for ‘current’ customers of the bank’s loan portfolio. In the next post we will consider the step-by-step methodology for determining best and worst case profitability of the loan portfolio.