The Bank of England Says Your Risk Weights Are Understated — Who’s Right?

Last week’s Bank of England pronouncement on the need for banks to raise more capital expresses more skepticism from the Financial Policy Committee, which has suggested that assets are overvalued and risk weights understated.

This is more evidence that banks need reliable ways to understand the forward-looking picture on asset value and risk weights — not only to run their business better, but to win the confidence of regulators. That’s something FICO has worked on in developing Economic Impact Services, which enable banks to implement Probability of Default (PD) models that reflect future economic conditions.

So what would your risk weights look like if the economy gets back to normal? That’s exactly what you can discover using economic-impact models. Let’s say interest rates will be at 5%, GDP at 2.5%, unemployment at 5% and house price at inflation 7%. Economic-impact models can tell you what the risk weights would be for the portfolio as a whole and across the risk spectrum of the portfolio. This is quite useful if you want to know your bank’s outlook and explore strategic options.