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Boost to banks as ‘next generation’ credit risk model paves way for personalised interest rates PDF Print E-mail
Friday, 07 August 2015

A new model to help banks more accurately assess the volume and timing of customer defaults could provide the key to the ‘next generation’ of credit risk modelling, protecting against institutional instability as well as paving the way for personalised consumer interest rates. The model is set to be revealed at a global gathering of credit experts in Edinburgh in August.

The ‘intensity model’ developed by Professor Jonathan Crook and Dr Mindy Leow at the University of Edinburgh Business School is a leap forward compared to current risk modelling used by banks. It provides a way to assess the probability of a customer in any given month, rather than just in a 12 month period, falling behind with their payment. It is the first model to bring macroeconomic considerations together with micro predictors based on previous behaviours, in order to reduce the £13.2 billion black hole created by defaults each year.
Furthermore, it can accurately assess how far behind a customer is likely to fall; including by one or two payments rather than predicting outcomes purely in terms of default. As a result of this, banks using the model will be in a position to tailor interest rates to consumers based on far more accurate probabilities of late payments or defaults, giving them a competitive edge.
The model also provides a solution to institutional instability by incorporating the ability to predict defaults even against wider macro-economic backdrops; therefore enabling banks to accurately anticipate capital reserve requirements and to flex them accordingly.
The model is likely to become highly relevant in the near future. It will help banks meet the requirements of a new accounting standard being introduced in early 2018, IFRS9, which asks that banks calculate the present value of credit losses expected in the future.
Professor Jonathan Crook will be presenting the intensity model at the Credit Scoring and Credit Control conference, held at the School at the end of August, in front of nearly 400 experts.
Professor Crook, Professor of Business Economics and Director of the Credit Research Centre at the University of Edinburgh Business School said:

“The intensity model provides a huge opportunity for lenders to identify the capital at risk from defaults, and to stress-test their systems by predicting delinquency and default levels in the event of another credit crisis to a more accurate degree than ever before. This really is the next generation of risk modelling.”
Simon Thompson, Chief Executive of the Chartered Banker Institute said:

“The work of Professor Crook and his colleagues at the Credit Research Centre is leading the way in the development of credit risk models. If employed across the financial sector this new model could play a significant role in helping banks and regulators take steps to avoid the build-up of excessive consumer debt, leading to difficulties for individuals and institutions alike.”
The 14th bi-annual Credit Scoring and Credit Control Conference will be held at the University of Edinburgh Business School’s Credit Research Centre from the 26-28th August. Around 400 experts will attend Europe’s leading conference on the topic to discuss the latest findings and issues in the field.

(Source - Edinburgh Business School Press Release)


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