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Forecasting Banks’ Corporate Loan Losses Under Stress: A New Corporate Default Model

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We present a new corporate default model, one of the building blocks of the Bank of Canada’s bank stress-testing infrastructure. The model is used to forecast corporate loan losses of the Canadian banking sector under stress.

We introduce two main innovations. First, we tackle a data gap by reconstructing historical default probabilities for banks’ corporate loan portfolios. Second, we estimate tail elasticities to capture non-linear relationships between macrofinancial conditions and corporate default probabilities.

By explicitly modelling default probabilities associated with macroeconomic tail events, this model significantly improves the Bank of Canada’s stress-testing infrastructure.