Former chairman of Australian regulator urges credit risk rethink

Banks need to move their focus from credit risk measurement to credit risk management, according to Jeffrey Carmichael, former chairman of the Australian Prudential Regulation Authority.

Carmichael made his call for a greater concentration on credit risk management during an address at the World Bank in Washington, DC. His talk was part of a workshop on assessing, managing and supervising financial risk, focusing on emerging markets.

“A lot of focus is now on the IT [information technology] systems that measure risk,” said Carmichael, who is now a consultant. He told the audience of risk professionals from emerging markets that, while a credit risk model is a set of procedures involving measurement and management, the latter should be the model’s main goal.

Banks calculate quantities such as loss-given default and probability of default, and even calculate correlations after taking on credit risk, but Carmichael said they need to go further and make greater use of this kind of information to help them decide whether or not to take on the risk in the first place. During his address, Carmichael cautioned that, though mark-to-market models are “the way of the future”, a lack of pricing information is leading some banks into making “[potentially problematic] heroic assumptions”.