The changing environment and regulatory policies in the financial sector have encouraged the use of credit risk models, either in-house or commercial models.
As regulations continue to evolve, there are several challenges with regards to model development and validation that keep model practitioners on their toes, according to a recent article by business analytics company SAS.
- Data Warehousing – The most important part of a credit risk model is the data set behind it, both its granularity and representativeness. In an earlier post, we explained how the phrase “Garbage in, garbage out” holds true for banking credit risk models.
- Scarce default history – If the data set contains only a small sample of defaults, accurate predictions can become difficult, and methods such as under or over sampling must be considered.
- Reject inference – The article mentions several potential methodologies such as parceling, fuzzy augmentation, etc. that can be applied for reject inference.
- Forward-looking indicators – There are several metrics such as Cash to Assets ratio, EBITDA to Assets, Debt Service Coverage Ratio that can help predict probability of default. Knowing which of these or more macroeconomic factors to use, can be a hurdle to model development.
- Accurate models – The accuracy of a credit risk model is incredibly important, both to satisfy requirements with Basel risk assessment and to minimize risk for the institution.
View the methodology behind Sageworks’ Probability of Default Model here.
Read the entire SAS article here.
What’s behind this transparency movement? And why does the CEO of search-engine optimization software developer SEOMoz post his company’s recent sales and subscription data, as well as detailed information about who owns how much of the company and upcoming plans?
SEOMoz labels transparency as one of six core values for the company, saying on its website that transparency improves the company in several ways, including holding itself accountable to customers, giving subscribers a sense of ownership (equating with brand loyalty) and keeping the company honest and realistic about limitations.
There are several trends and factors driving this broader trend of increased transparency among companies:
1. Changes brought about by the Internet
2. Growing mistrust of corporate entities
3. The financial crisis
4. Increased interdependence among business partners
5. The need to manage risk and perception of risk
Some drivers are societal, such as the explosion of information available through social media and other online sources. Others are more directly tied to recent experiences in business that have prompted or forced changes in the way organizations provide information.
We will dive into each of these trends more deeply, but you can read more about them as well as how a company can increase transparency in the whitepaper “Transparency: Shedding Light to Grow Your Businesses.”
Financial institutions in the United States are reducing concentrations of loans in the real estate sector and focusing on increasing their portfolio shares in the industrial and commercial sector, according to a recent article in Forbes. But experts say that so far, this does not mean an easing of lending standards for businesses that are less profitable and have otherwise found financing difficult in the past.
Commercial and industrial loans at all commercial banks have increased 24 percent in the last two years, according to data from the St. Louis Fed’s FRED system. Since 2010, C&I loans as a share of the average U.S. bank’s portfolio have increased, from 15 percent of total loans to 17 percent, the Forbes report said.
Obtaining business credit and offering trade credit has been a practice of growing businesses and acquiring customers for several decades. For most companies, offering trade credit isn’t optional since it’s likely that competitors do offer it, according to Inc. Magazine. Having a smart credit policy and managing receivables is required for businesses to mitigate the risks and opportunity costs of not collecting cash, the magazine says.
“If you’re not turning receivables into cash, it affects the way you pay your vendors and affects your vendors’ credit decisions toward your company,” Doug Swafford, credit and collections manager for U.S. Xpress Enterprises, a trucking company in Chattanooga, Tennessee told the magazine.