For Basel Modeling, Sophisticated May Beat Simple

There has been a great deal of criticism recently of the internal risk ratings approach for Basel II, with politicians in the UK suggesting that bankers – in refining their risk models – are “fiddling the books” to lower their capital requirements. At the same time, some have said that the Basel modeling requirements are too complex because of the number of approaches being used to measure risk.

Andrew Bailey, Deputy Head of the Financial Services Authority’s Prudential Business Unit, and Director of UK Banks and Building Societies, made his own feelings clear when he addressed the Bank of America Merrill Lynch Conference in London on November 6. In his speech on the challenges in assessing capital requirements for banks, he supported the use of multiple tools that will improve a risk-based approach to managing capital. “Simplicity is not about one-club golf and it is not about abandoning risk-based regulation,” he said.

FICO have been learning from the crisis and have sharpened our own modeling capability to help lenders predict the impact of changes in the macro environment on both consumer and SME borrowers. Regulators are showing their faith in internal models, and should keep apprised of advances in risk analytics, which can definitely help bring precision and control to predicting and managing bank risk.