Development of Rating Models under IFRS 9

Before the release of the IFRS 9 standard Financial Instruments in 2014, the development of a rank ordering mechanism was mostly known through the Basel capital accords requirements for the computation of regulatory capital, as well as the economic capital models used for the estimation of internal capital needs. Most institutions would have been relying on application scorecards for ranking clients at application and assess their suitability to be granted a loan in line with their own risk tolerance. However, only a small number of institutions would have relied on behavioral scorecards. Both the Basel III Internal Rating Based Approach (IRBA) and IFRS 9 are principle based and offer their users a variety of modelling approaches. Hence, financial institutions are allowed to implement their own rating models. However, under IRBA the rating system must meet specific minimum requirements which are not required under IFRS 9. The article focuses on highlighting a variety of rating methods and systems applicable under the IFRS 9 framework. Hence, it presents a series of statistical and non-statistical models for building and estimating the rating system. Furthermore, the benefits and drawbacks are presented for each approach. The paper concludes with an analysis of the models under the IFRS 9 framework.