The ‘intensity model’, developed at the University of Edinburgh Business School, is said to be good news for those with high credit ratings. It also means banks can better protect themselves from the £13.2 billion lost to defaults each year.
Banks using the new system will be able to much more accurately predict which borrowers will miss loan repayments and when, enabling them to offer ‘tailor-made’ interest rates based on specific past borrowing behaviour and credit risk. Borrowers with poor credit scores and histories will pay higher interest while those with a good credit profile will increasingly benefit from lower interest rates as lending institutions begin to compete more vigorously on lending rates.
Professor Jonathan Crook’s and Dr Mindy Leow’s model is based on a new application of statistical theory that means banks can more accurately predict when and where their customers are most likely to fall behind on payments – and go beyond that to ascertain the customers that will continue to fall further behind and default. They claim that it’s a more accurate and informative way of analysing risk, which goes beyond working out a customer’s risk of default over a 12 month period, to analysing the risk of default – or even of falling one payment behind in any given month.
The model then goes even further, and can predict these risks against different macro-economic backgrounds – meaning banks can more accurately stress-test their systems and ensure they are retaining enough capital to protect themselves, reducing the chances of getting into difficulties in the event of a future credit crunch.
Professor Jonathan Crook said:
“The intensity model is designed to take an already effective system used by banks, and create the next generation of risk modelling.
“The ability to accurately predict consumer delinquency, default and catch up payments over any given period in the life of a loan, and even stress-test these against different economic conditions, is a hugely powerful tool that will benefit consumers and lenders, and help to ensure our banking system is better protected in the future – which is good for the economy as a whole. This model really could bring about a seismic shift in how banks assess credit risk – something people with poorer credit histories should start thinking about now if they don’t want to be penalised when borrowing in the near future.”
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.”
