Models get a thrashing
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Models get a thrashing

Leading banks, academics and regulators spent two days stress-testing themselves and the latest in credit risk models. David Shirreff reports.

Was it all in vain? More than 200 credit experts and their regulators spent two days deep underground last month thrashing out the virtues and vices of credit risk modelling. At the end of this session, two floors down in The Pit cinema at London's Barbican Centre, a panel including a trio of European regulators concluded that the models were "half-baked" and could not be used to set regulatory capital.

The financial risk industry is not discouraged. The fact that there was a conference at all, organized by the Bank of England and the UK's Financial Services Authority (FSA), "shows they're taking us seriously, which they wouldn't have done a year ago", says one industry source.

The modellers' interim goal, besides the holy grail of modelling credit risk perfectly, is to persuade regulators to modify or replace the crude credit risk ratios imposed by the 1988 Basle Accord on capital adequacy. The accord demands an across-the-board capital to risk assets ratio of 8%, which is acknowledged to have forced most banks to stock up on capital - good. But the risk weightings are absurd for today's conditions - for example they are five times more favourable to an OECD bank, however poorly rated, than to a non-bank company, even if it's triple-A-rated - bad.

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