IMPACT OF POSSIBLE RISE IN DEFAULT RATES IN THE US
2021 ended in all-time low default rates in the US, with the S&P/Experian Consumer Credit Default Composite Index under 0.4 percent.
However, defaults have increased since the beginning of the year. The world is experiencing an inflation rate that we thought belonged in the history books and governments are increasing interest rates to try to break it. Recession may follow. How far will default rates climb? How will this volatility impact the financial market? How can banks adapt while still dealing with the ongoing coronavirus (COVID-19) pandemic?
In the US, most of the medium and smaller banks traditionally rely solely on external credit scores. After all, why invest in an internal modelling framework, resources and tools, with steep learning curves, if prevailing default rates are well under 1 percent? Also, there is a long, complex process to get new credit models approved by regulators, and in any case many credit exposures can be securitised.
These points may discourage development of an internal model development area. But as recession looms, many banks will need to plan how to face these more volatile market conditions and find some opportunities for modernising their credit risk modelling and decisioning processes. Consider that currently credit cards already present a default rate above 5 percent.
The rest of the world is used to higher default rates. Several countries, such as those in Latin America (LATAM), have experience with consumer default rates that range between 3 and 6 percent. Banks in developing countries rely heavily on their own internal modelling frameworks to complement information from credit bureaus, especially since almost 25 percent of the population in LATAM either is not in the financial market, or there is very scarce credit data available. These banks use analytics through most of their decisioning processes and have several use cases that do not need to go through external regulators and can be deployed frequently and easily.
Oct-Dec 2022 Issue
SAS