Early Warning expert speaks

Early Warning expert speaks

The importance of the EWS system is one of the most crucial lessons learnt from the current financial crisis. With the help of an EWS supported credit monitoring system the Bank would be able to avoid unnecessary credit losses and even to generate new business for well performing customers.

The early recognition of the potentially problematic exposures or clients could be based on the up-to-date prediction of the probability of default (PD) using a behavioral approach. The prediction model could be expert based or statistical. Obviously any statistical model requires a thorough backtesting (i.e. root cause analysis, EWS signal significance tests) and an expert based validation as well (plausibility checking, reject inference considerations). The major advantage of a behavioral concept is that the discriminatory power of it (i.e. how well the model can differentiate between good and bad customer in advance) significantly outperforms the strength of a purely application data based rating or scoring system. The simple reason for this is that a behavioral model can incorporate all the precious information generated after the origination (e.g. account balance history, changes in availability information, latest financial data, industrial outlook, rating path).

Based on the forecasted PD the Bank can identify the most profitable way of the customer relationship management. The business goal is to select the action type which would cause the largest increase in the expected profit or in similar customer value measures, calculated on the basis of the expected reduction in the PD, lengthened customer lifetime and the cost of the treatment.

In many cases the Bank will experience an improvement in the creditworthiness of the client (a decreasing PD predicted by the behavioral model). In these cases a X-sell or up-sell action could generate the maximum profit.

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