Reverse Reengineering of Risk

Reverse Reengineering of Risk
Bank Technology News Wednesday, October 1, 2008
By Clark Abrahams
http://www.americanbanker.com/printthis.html?id=20080929C4VN8N2E&btn=true

The article calls for use of comprehensive credit assessment framework (CCAF). This uses “advanced computing technology and a sound, safe model development and validation process. The CCAF approach naturally affords a sustainable and sensible segmentation based on all primary credit factors; providing ongoing monitoring of the impact of those actions in a comprehensive and efficient manner”. This increases qualification criteria, new actions for each segments and model possible scenarios.

Credit-risk scoring came into use in the banking industry in the 1970s which ended the judgmental and biased lending decisions that were used. The recent economic crisis exposed that the science of risk scoring is somewhat flawed analytics that made assumptions, like incomes don't matter and those who pay in cash are riskier bets. The current system has two fundamental problems such as weakened underwriting standards and degraded loan quality. The current credit scoring method has done a subpar job of assessing risk in dealing with the current subprime mortgage market. Most underwriting systems did not capture all of the risk factors that the current incarnation of the market faces.

This can be seen in particular when the conventional risk models were applied to non-conventional loan products. The lenders who depend on these credit-scoring systems are using the credit risk models inaccurately and incompletely for their daily business use. Secondly, there is a blind spot in underwriting practices that are used currently. There is too much dependence on quantitative models and automated underwriting systems employed today. In sort, the technology that is in place today is too over abundantly used and relied on to make judgment on risks when it comes to the lending of credit.

With the current use of technology and the current economic crisis there is a need for revamping the credit scoring system and how much faith is placed in technology. The key point is that as our technological capability and our economic means expand, we must update pass used measures. The credit scouring system has not changed as we have. The current system has not failed us, we have failed the system. We have failed to continually improve and adapt the system to ensure proper results.

With the creation of new forms of investments new measures must be put into place to change our old fundamentals of risk management in the credit community. More faith must be placed in our own physical means of business and not rely on old outdated methods. We must not totally rely on one method to determine credit risks, especially if the current means that we employ do not take into account the totally variables that exist in the market and person to person.

The technology and models that we employ is a great tool that we have ability to use. But we must not place absolute belief in them. We must ensure that as the investment opportunities change, we must change the way the tools are used. Hopefully, we can learn from the mistakes that have been made to ensure such crisis do not happen again.