While an overdue economic downturn has been long discussed, arguably no one could have foreseen the economic disruption from COVID-19 to the extent that’s been witnessed thus far. But now that we’re here, is there a line of sight to financial institutions’ next move?
With the current situation marked by a history-making rise in unemployment, massive amounts of uncertainty within the market as well as for consumers and small businesses and consumer spending changes, loss forecasting is more important now than ever before.
After the longest period of economic growth in history, financial institutions are caught off guard. While large banks are more prepared as they have stress testing capabilities in place and are estimating the potential large impact on their loss allowances, the since-delayed CECL requirements emphasized forecasting for the masses, and yet many are still under-equipped.
Loss forecasting has evolved from a need for a small few to now a necessary strategy for all.
While some financial institutions will look to loss forecasting to potentially reduce the severity of impact for the path ahead during these times (or even how they might come out stronger than their competition), for many, loss forecasting is the key to survival. Bare necessities. Understanding the possible outcomes of the pandemic’s impact is necessary to make critical business decisions.
Lenders are likely receiving numerous questions about their portfolios and possible outcomes. These questions include, but are not limited to:
- What could the range of outcomes to my portfolio based on expert forecasts of macroeconomic conditions?
- How will I make lending decisions in the short term?
- Do my models need to change?
- How bad could charge offs be for my portfolio?
- If I have reduced marketing and application flows, at what point do I need to begin opening new accounts or consider portfolio acquisitions?
How can lenders get answers? Loss forecasting.
As Mohammed Chaudhri, Experian Chief Economist, said, “Loss forecasting is more pivotal than ever…existing models are not going to be up to the task of accurately predicting losses.”
Whatever questions you’re receiving, you need certain necessary pieces of information to navigate this new era of loss forecasting. Those pieces are frequently updated client and industry data; ongoing access to expert macroeconomic forecasts; and sophisticated and evolved forecasting models.
Client and Industry Data
Loan-level data, bankruptcy scores and customer-level attributes are key insights to fueling loss forecasting models. By combining several data sets and scores (and a comprehensive history of both) your organization can see greater benefits.
As has been mentioned numerous times, the economic impact resulting from COVID-19 is not at all like the Great Recession. As such, leveraging macroeconomic forecasts, and specifically COVID-19 forecasts, is critical to analyzing the potential impacts to your organization.
Whether building models on your own or leveraging an expert, the key ingredients include the innerworkings of the model, leveraging historical data and making sure that both the models and the data are updated regularly to ensure you have the most accurate, thorough forecasts available. Also, leveraging machine learning tools is imperative for model specification and evaluation.
Fortunately, while model building and loss forecasting used to be synonymous with countless resources and dollar signs, innovation and digital transformation have made these strategies within reach for financial institutions of all sizes.
Incorporating the right data (and ensuring that data is regularly updated), with the right tools and macroeconomic scenarios (including COVID-19, upside, baseline, adverse and severely adverse scenarios) enables you to get a line of sight into the actions you need to take now. Empowered with insights to compare and benchmark results, discover the cause of changes in results, explore result scenarios in advance, and access recommended optimizations, loss forecasting enables you to focus on the critical decisions your business depends on.
Experian helps you with loss forecasting for now and the future. For more information, including an on-demand webinar Experian presented with Oliver Wyman as well as the opportunity to engage Experian experts into your loss forecasting strategy, please click the button below.