COVID-19: Implications For Risk Modelling

As the COVID-19 crisis keeps Australians away from their usual activities, banks’ first duty is to help clients and society function as well as possible. But lenders must also plan for the future, and that task has been made more complicated by emergency measures to deal with the economic fallout from the pandemic.

Australia’s government, central bank, and financial regulator have taken unprecedented measures to support individuals and businesses, including loan guarantees and other wage subsidies, while banks have introduced their own initiatives, such as repayment holidays and forbearance. Plenty of firms and individuals will benefit from government action or exercise a forbearance period; while they will not repay their loans according to the original schedule, these borrowers will not be in default. So, banks will have to strip out the effects of emergency measures from the models they use to forecast risk.

In some cases, such as use of the Australian government’s Coronavirus SME Guarantee Scheme, the effects will be relatively simple to account for. But in other cases the effects will be harder to isolate. Income tax rebates, for example, will fundamentally alter cashflow data and financial ratios, so banks will need to reconstruct operating cashflows with and without them.

Banks must make decisions now that will determine how they collect, interpret, and ultimately use 2020 credit and default data in the future. Getting this right will be complex and demanding given competing priorities and short-term pressure, but attempting to reverse engineer this data in the future will be nigh-impossible. Banks that have substantially invested in both credit risk and transaction data will have an advantage.

These are highly challenging times for the Australian banking system, and banks will have to make a great effort to balance competing priorities. As they take urgent action to deal with the severe economic downturn, they should not forget that they will, in future, need to account for the substantial echo that will be left in default and financial data. This implies careful capture of data today that will let them understand the myriad idiosyncratic aspects of the crisis. If banks do this, they will emerge from the crisis stronger, and be better able to prepare for the next one.