According to a recent European Banking Authority report, overall risk indicators and market sentiment are strengthening, however, the signs of recovery remain modest and fragile. Quality of loan portfolios continue to decline and that remains a concern. Credit quality was, and still is, the main source of risk. As a result, credit monitoring has become a priority for financial institutions, and Early Warning systems are becoming essential for improving portfolio performance.
Hear more from Davide Capuzzo, Analytics Director of CRIF in this article.
What is the role of these systems within credit institutions today?
"The role of Early Warning systems is to predict the deterioration of credit positions as early as possible, enabling managers to find solutions which avoid the borrower defaulting, or in any case limit the economic impact. Nowadays, their role is changing from a simple aid for managers to manage loan portfolio assets, to a system based not only on priorities but also on well-defined rules and responsibilities, which are in turn monitored. The subject of Early Warning systems is a hot topic because, whereas it previously meant 'identification', today it is closely associated with ‘action’ ‘and results’".
But is this not the job of internal rating systems?
"Internal rating systems are an integral part of Early Warning systems, but do not and cannot perform this function on their own for a number of reasons. They are in fact developed to give stable risk assessments over time at the expense of the reactivity required of an Early Warning system. They are not fed with the same types of event which characterize those systems, which include daily events. The situation predicted by an internal rating system is typically loan default, whereas Early Warning systems predict a status well before default, or even the simple deterioration of the status. Therefore, from a modeling point of view, they are two integrated systems, but which serve different purposes and processes".
