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Friday, October 24, 2014

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Update Newsletter: Summer 2003

Retail Credit Risk Management and Measurement

This is a summary of the opening remarks made by Philadelphia Fed President Anthony Santomero at the retail credit risk conference on April 24, 2003.

Over the past several decades there has been a sea change in the Federal Reserve's approach to regulation. The Fed's emphasis has shifted from portfolio restrictions and crude leverage ratios to a much more subtle approach to risk regulation.

While banks are indeed increasing their risk-modeling efforts, it should come as no surprise that historically the focus has been on the commercial side. However, despite this emphasis, retail credit is a substantial and increasing part of the risk borne by the banking industry. Recognizing this, the industry has begun to develop more sophisticated credit-scoring models for measuring retail risk. While the sophistication of automated credit scoring has increased, only recently have some institutions put resources into advanced methods of retail portfolio credit risk modeling.

At the Philadelphia Fed, we are leading a System-wide effort to develop a supervisory framework to evaluate bank practices in retail credit risk management, including internal risk rating systems. This project, which will enhance the Federal Reserve's ability to assess banking organizations' retail credit risk quantification methods, responds to gaps in the Basel II framework.

We have three main goals: First, we are documenting existing policies and practices among institutions capable of effectively measuring retail credit risk. Second, we are analyzing the reliability of current practices and assessing their weaknesses or gaps. Third, we want to identify major analytical issues in quantifying retail credit risk and to generate relevant research. Through 2003 and beyond, Philadelphia will continue to develop its ongoing research agenda on retail credit risk quantification.

However, the efforts of our Bank are not the last word on retail credit risk. Each new development works to encourage industry and regulators toward better risk management practices. With more experience and better data, risk parameters will change and models will get stronger. Rather than a uniform regulatory standard, financial institutions will develop their own assessments and procedures that accurately capture retail credit risk. In this way, the industry itself can lead the evolution of risk management—as ultimately it should.

We can take pride in the fact that we have come such a long way in a relatively short time. Yet, we don't have all the answers, which is why we had better keep working. This conference is an integral part of our work.