| Risk Analysis – Use and Importance |
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| Monday, 24 May 2010 02:00 |
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Risk analysis is a wide subject that covers many aspects in credit management. We will focus in this article on risk analysis as applied to monitor the population of existing customers. Following the application of scoring solutions for the acquisition of customers, it is imperative to monitor the performance of the solutions (models and scorecards) as well as the performance of the credit portfolio. The monitoring reports will indicate whether any shifts occurred in the population coming through the door, and will indicate how the population is performing in terms of risk. Monitoring is conducted in different stages. Integrity testing is carried out shortly after implementation in order to determine whether any implementation errors exist and whether any system changes were made during or shortly after model implementation. Standard monitoring is then conducted thereafter on a quarterly or ad-hoc basis to ensure that possible irregularities are identified as soon as possible in order to make the necessary changes before irreparable harm is done to the credit portfolio. The risk analysis and the monitoring function assist with indicating the following: • Changes that might appear on the operational side, as well as the impact of these changes • Any changes in the approval policy of the organisation • The take-up rate (percentage of accounts actively trading) • Any changes in the population since the model was developed • The significance of the shift in population and how it effects the stability and performance of the scoring solution • Shifts in risk distributions of the portfolio • The performance of the credit portfolio • The delinquent performance of the credit portfolio • The degree of delinquency & bad rate trends over a period of time • The seasonal performance of the credit portfolio Clients often disregard the need for, and the importance of monitoring the scoring solutions after implementation. Scorecard monitoring is also becoming increasingly important to ensure adherence to the NCA. It is crucial to know how the models are performing and whether they need to be recalibrated or redeveloped. Neglecting this vital service could have dire consequences over the long run. Monitoring the performance and behaviour of the scoring solution is just as fundamental as the need for, and the implementation of the scoring solution itself. Risk analysis and monitoring is necessary: • To ensure that the scoring solution is working as expected • To ensure that the scoring solution is used as originally intended • To identify problem areas and possible implementation errors • To create/enforce confidence in the scoring solution There are two types of analysis; analysis aimed at monitoring the performance and stability of the scorecard(s) and analysis aimed at monitoring the client portfolio with regards to delinquency. An example of analysis related to the performance and stability of the scorecards is the Population Stability Analysis which measures the change in score distribution of the current application population compared to the development population. The aim is to determine if there was a shift (with regards to risk) in the actual population coming through the door. Another example is the Stability Index Analysis which indicates for each scorecard variable, how the distribution (in size) of the development population compares to the actual distribution (in size) of the applications that were processed for this quarter. The closer these two size distributions are, the less variance is prevailing between the two populations measured, indicating stability in the particular variable. A common example of analysis aimed at monitoring the client portfolio with regards to delinquency is the “Vintage” risk analysis. In this analysis, the delinquent performance of accounts is tracked over a period of time. The accounts opened within a specific month are tracked at each month end. In other words, the delinquent performance of all the accounts that were opened between the first of a month and the end of the same month are tracked with each month-end run. Vintage reports for delinquency can be shown for the account in 1+, 2+ and 3+ cycles of delinquency. There are many other risk analyses that can be performed to monitor the risk solutions and the credit portfolio. The examples above try to provide an insight into this critical function in credit management. |
| Last Updated on Monday, 24 May 2010 09:45 |