Adding Loan Loss Assumptions

You can set up loan loss assumptions, which are used in the instrument calculations, on the Loan Applications setup page.

1. Select Setup > Assumptions from the menu.
   The Loan Applications page opens.
2. Select the Loan Losses tab.
3. Select Add.
4. Enter one of the institution's loan types as the Name for the risk category that you are creating.

   You can select the risk category from the list after you save it.

   The next part of the setup process involves creating a series of risk ratings. A row for the first rating value appears automatically when you initially select Add.

5. Enter a risk rating in the Rating column.
   The rating itself is an indicator of the riskiness of a loan, considering the probability of default and the loss given default. The Rating can be a number, a character, or a combination of both.
6. Complete the following fields to define the rating:

   Annual Loss

   This field is the loan loss expense that can be attributed to the loan for a particular risk rating.

   Max Loss

   This field is the lifetime ceiling for the loan loss expense that can be attributed to the loan for a particular risk rating over the expected life of the loan.

   ROE Target Change

   This field directly affects the return on equity (ROE) targets that have been established for the loan products. Typically, a riskier loan has a higher target compared to a less risky loan as determined by risk ratings.

   Capital Change

   This field directly affects the capital allocation, and, in turn, calculated loan profitability metrics. Typically, a riskier loan has more capital allocated to it compared to a less risky loan as determined by risk ratings.

   Default

   The field indicates that the rating is used to prefill the Loan Risk Rating field in the loan form as a new loan is priced.

   Note: The Loan Loss risk category assigned to the product type selected for the new loan determines the risk rating items that appear in the Loan Risk Rating drop-down list in the loan form.

   You can enter a percentage from 0.00 through 100 in any of the four fields. A user-defined value is not required for every field.

   These settings affect profitability metrics, such as projected profit and projected ROE, calculated for loan instruments.

7. Select Add Row to add additional rating thresholds.
8. Enter a name for each additional rating in the Rating column.
   Each rating name that you choose must be unique.
9. Enter the appropriate values in the loss and change fields.
10. Select Save.