To Rate or Not To Rate – Reloaded!

The contentious debate on rating models, where the industry is going and the direction where the regulators are taking risk measurement are either diverging or running in parallel or going to collide.

As you can tell, rating is something we find very interesting and we immerse ourselves in it, and develop models for clients, models are within the core of our products, and we share our views whenever the opportunity arises.

A recent article in the financial times, referred to how Banks are cutting back on their big budgets for PhDs and complicated risk software due to a clamp down by regulators to stop them from using methodologies that make their portfolios look better than what they really are. The investment in model technology and clever number crunchers is phinominal.

The regulator’s approach makes sense, and no doubt it will be refined over time, but everyone is currently rating credits on different basis which does not make sense. There should be a uniform mechanism used by all financial services and that is centrally reported to the regulator. If the banks want to run their own models for their own internal purposes then well and good, but in parallel should also use a measure that everyone abides by. The regulators are simplifying the rating/scoring methodology and an agreed ratio tests and approach.

Whilst sophisticated models are not going away anytime soon, they should become more of an analytical tool to build a better understanding of the risk, tweaked to differentiate better between types of risks, asset classes and stress scenarios. We understand the benefits of representing the organisation’s portfolio in a specific light to reduce provisions or capital needs, but models will play a different role in the future and will be embraced as an internal protection mechanism.

We at Smartlogiq are model agnostic, we support specific vendor models as well as internal models in our applications and we provide a model development platform, either way models are a tool in a mix bag of risk measurement and monitoring coupled with the ever important expert-judgement of experienced staff.