A Methodology to Measure Impacts of Scenarios Through Expected Credit Losses

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.