What to Expect Next in the Inclusion of Climate Change Risk and ESG in the Credit Risk Environment?

Could the new technological developments reduce the common key concerns in credit risk management?

How has technology been changing and optimising credit risk management, and what will change in 2023?

Statistical models in credit risk have been applied since decades and technology has been key since the introduction of computerised systems in the 1960s. The last decade, computing power, data availability and technological development speeded up creating advanced opportunities in credit risk management:

• Data analytics and machine learning offer the possibility to assess more data, more risk drivers, more statistical methods and further improve the performance of credit risk models;
• Application of transaction monitoring and transaction-based models allow for (near) real time monitoring and more timely insight in credit risk at loan application, early warning signals, fraud detection, and other anomalies;
• Timelines of the credit granting process reduced dramatically through automation of the loan application at the bank or through funding platforms, giving borrowers quick access to capital;
• Blockchainopens up a new world of opportunity for digital lending and a new data source for credit risk modelling.

Nevertheless, these new technological developments do not reduce the common key concerns in credit risk management such as data quality, data definition and remediation efforts and the assessment of your results. It increases complexity and model risk. Emphasis is required on the interpretability of modelling components, combining business understanding with statistical skills and knowledge of data and data processes to explain modelling results. Our presentation at the 16th Annual Banking Credit Risk Management Summit will further discuss the interpretation of machine learning models.

Coming years, our modelling experts will also be confronted with data that includes the trend breach in credit risk drivers and observed defaults during the covid19 period. Refer to our white paper on Managing the impact of COVID-19 on credit risk models for further elaboration.

What are the most expected major changes in the credit risk environment?

In addition to items mentioned in the previous question (and pressure on the impairments and bank performance from geopolitical and macro-economic developments), we expect a next step in the inclusion of climate change risk and ESG in the credit risk environment. Banks play a pivotal role in the transition to a sustainable economy, see our article on Climate change risk. We learned from a round table Zanders organised in 2022 that most participating banks have made efforts to include ESG risk factors in their credit risk management processes. Nevertheless, many efforts are still required to comply with all regulatory expectations regarding this topic as we explain in our article on Integrating ESG risks into a bank’s credit risk framework.

How could banks stay top-of-mind and top-of-wallet in rising competition from fintech?

Competition from fintech companies and start-ups is fierce. Banks are addressing that through investments in customer experience, user-friendly platforms and a broad range of banking services. Banks have the advantage of data availability and the ability to reduce timelines of the credit granting process and early warning systems. Reducing these timelines requires sufficient data (including observed defaults) and an investment in resources such as modelling skills where the banks in general have an advantage.

One of the main difference with its fintech competitors concerns the regulatory scrutiny by supervisors which is exponentially larger at banks. Keeping the house in order and compliant with the extensive regulation is still one of the main attention points and remains a large claim to resources in 2023. ECB has increased its focus on credit classification, the alignment of credit granting models, with capital and IFRS 9, the reporting of forbearance, defaults, non-performing loans, staging and other credit risk events. Consistency is required in models, policies, reporting and day-to-day processes, causing another large resource claim at many banks.

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Zanders is a leading international consulting firm specialising in treasury management, risk management, treasury technology and corporate finance. We deliver consulting services for corporates, financial institutions, public sector entities and NGOs. Our company, established in 1994 and employing over 225 professionals, has an excellent track record and a diversified international client portfolio. Our added value is to assist our clients from ‘idea to implementation’, bringing deep domain knowledge, best practices, and latest developments together into the pragmatic treasury, risk, and corporate finance advice and cutting-edge solutions.