ECCB 2022-2023 Annual Report and Financial Statements

Eastern Caribbean Central Bank Notes to the Financial Statements For the year ended 31 March 2023 (Expressed in Eastern Caribbean dollars)

3. Financial risk management (continued)

Credit risk (continued)

b)

(iii) Amounts arising from ECL (continued)

(i) Expected credit loss measurement (continued)

b) Incorporation of forward-looking information (continued)

The Bank formulates three macroeconomic scenarios: a base case, which is the median scenario, one upside scenario and one downside scenario. The base case scenario captures our view of the most likely economic future outcome and is assigned the highest weighting. The upside and downside scenarios are set relative to the base scenario based on reasonably possible alternative macroeconomic conditions. Scenarios are probability-weighted according to the best estimate of their relative likelihood based on historical frequency and current trends and conditions. The scenario weightings are determined by a combination of statistical analysis and expert credit judgement, taking account of the range of possible outcomes. After the ECL calculation has been generated for each scenario, a probability weight is applied to each scenario based on the likelihood of occurrence to arrive at a final probability-weighted ECL. As with any economic forecasts, the projections and likelihoods of occurrence are subject to a high degree of inherent uncertainty and therefore the actual outcomes may be significantly different to those projected. Incorporating forward-looking information increases the degree of judgement required as to how changes in these macroeconomic factors will affect ECLs. Hence, the methodologies and assumptions including any forecasts of future economic conditions are reviewed regularly.

c) Computation of the expected credit losses

The key inputs into the measurement of ECL are the term structure of the following variables:

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probability of default (PD); loss given default (LGD); and exposure at default (EAD).

ECL for exposures in Stage 1 are calculated by multiplying the 12-month PD by LGD and EAD. Lifetime ECL are calculated by multiplying the lifetime PD by LGD and EAD.

PD represents the likelihood of a borrower defaulting on its financial obligation, either over the next twelve (12-month PD) or over the remaining lifetime (lifetime PD) of the obligation.

LGD is the magnitude of the likely loss if there is a default. LGD’s are determined based on the factors which impact the recoveries made post default. Theses vary by product type. The Bank estimates LGD parameters based on the history of recovery rates of claims against defaulted counterparties.

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