COVID-19: Impact and

recommendations for credit

risk management

The COVID-19 pandemic has posed far reaching consequences in the US and around the world. In a
world now starkly divided into pre- and post-COVID times, it's imperative to examine the impact
of this public health crisis on businesses and societies.

With the increasing health and human tolls and restriction on people's mobility, the pandemic has
stalled the economic engine worldwide. The repercussions of this are not limited to any one
industry. The banking and financial services sector is also facing severe challenges, perhaps its
biggest in many decades.

The objective of this paper is to outline the challenges posed by the pandemic and present
proposals for concrete actions through which banks can identify, manage, and mitigate credit risk
during these times. This paper focuses on data and analytics interventions to mitigate potential
challenges.

The recommended interventions have been outlined across customer credit lifecycle and banks'
regulatory obligations on stress testing and reserving, and includes diagnostics and analytics,
enhanced reporting and monitoring, and model adjustments. The key consideration is to keep the
implementation cycle time short and iterative in nature to learn from the response and make
necessary adjustments as the crisis evolves.
COVID 19 is adversely impacting banks'
credit portfolios
As the current economic crisis unfolds against the backdrop of a public health emergency, the
unprecedented rise in unemployment and disruption in economic activity is putting a strain on the
solvency of customers and companies. A larger number of distressed customers are seeking help
for financial hardships across consumer and commercial lending portfolios. Highlighted below are
some statistics that demonstrate the severity of impact on consumers.

Mortgage forbearance increased sharply showing nearly 3,000% increase from March 2020 to
May 2020
Auto loan modification requests increased nearly 10 times across the industry since the
pandemic began
Inquiries for credit cards, new mortgages, and auto loans dropped by 30–50% compared to the
same time last year

To prepare for such extreme shocks and uncertainty, large US banks have increased their loss
provisions by ~3–4 times for Q1 2020 as compared to Q4 2019, based on their expectations of
impending defaults and charge-offs.

The table below elaborates on the impact of COVID 19 on customer credit lifecycle, reserving, and
capital estimation.

Table 1: Impact areas and implications on retail and

commercial lending portfolios
 IMPACT AREAS IMPLICATIONS ON RETAIL AND COMMERCIAL LENDING

• Increase in bad loans

Acquisition • Deteriorating portfolio quality
Reduction in new bookings
• Origination models don't perform as expected
•
Account
•• Increase
Elevated delinquencies and credit losses across lending portfolios
in segments with high impairments/risk concentration
management • Emergence ofnew risk drivers
• Behavioral models showing breakage in performance
•• Loan
Strained cash flow and liquidity constraint
restructuring and payment deferrals
Collections • Relief, and Economic Security (CARES) Act implies deferred
Forbearance considerations - for example, the Coronavirus Aid,

delinquency
• Increase in call volume and customer complaints

• magnitude
Unprecedented increase in expected credit losses because of
and speed of macroeconomic deterioration
Reserving and
capital planning • Stress scenarios impact on revenue and losses across segments
•• Reserving and stress-testing models produce unreliable outcomes
Risk-weighted asset impact beca use of higher volatility

When the economic environment shifts as quickly as it has in this crisis, the government,
regulators and financial institutions need to employ a slew of actions to manage and mitigate
credit risk (see a summary of government and regulators’ actions in the Appendix).

Proposal for banks' credit risk management

interventions
Banks have provided customers with relief measures such as payment deferrals, mortgage
forbearance, loan modifications, late fee waivers, and suspension in reporting account
delinquencies.

Such interventions, while necessary to provide temporary relief to customers, must also be
accompanied by enhanced risk management actions across impact areas:

A. Acquisition

B. Account management

C. Collections

D. Reserving and Capital Planning

The actions can be divided into three broad pillars of intervention across the credit lifecycle:
 1 Diagnostics and analytics

o2 Enhanced reporting and monitoring

o3 Model adjustments

Table 2: Recommendations for credit risk management

interventions
 AREA DIAGNOSTICS AND MeDEL
ANALYTICS ADJUSTMENTS
Acquisition • Adjust cutoffs based on
• onImpact of cut-off changes First line actions
risk appetite approval rate
• Enhanced model
• rule engine on top ofthe • changes at portfolio and
lmplement a decision P&L impact of strategy performance
monitoring with
origination score with segment level higher frequency,
COVID-19 variables and
segmentation
• Credit mix of new
bookings
additional
metrics, and
• Devise and automate
• Granular monitoring revised thresholds
frameworks to estímate
the profit and loss (P&L)
by region, risk bands,
product, employment
• Adjust model
assumptions and
impact of strategy type, and so on overlays
• What-if scenarios to
fine-tune origination
• Increased
monitoring
frequency of • Model
re-calibration
strategies, based on P&L using additional
impact credit bureau
• Bureau-based early
warning triggers
variables capturing
cash flow, payment
pattems, and so on
Account
management
• Credit and cash advance
line/limit reoptimization
• Additional risk KPis and
more granular portfolio
• Challenger model
development with
• Increase cutoffs for quality reporting shorter duration
line increases, revise
increase amounts and
• Track risk mitigation
strategies across
target variables

frequency segments Second line actions

• Adjust line-decrease
rules to limit potential
• Track rating downgrades
and higher draws • Monitor exception
approvals and
losses
• Early delinquency remediation
• Inactive account dosures/ reporting by segment actions
line decreases to reduce
exposure
• Early warning signals and
trigger-based monitoring
• Estímate
COVID-19 impact
• Card authorization
• Monitoring risk on model risk

•
tightening rules
lmpact estimation of
concentrations based on
employment type, region, • Develop model
heat map based
strategy changes cash flow variables onpandemic
• Residual value changes
and monitoring for auto
sensitivity for
prioritization
lending
• Agilemodel
• Increased monitoring
frequency
validation
process for rapid
Collections • Enhanced segmentation
of customer base
• strategy
Monitor collections
- troubled debt
deployment of
challengers
• Reset collections
strategies and treatment
restructures (TDR),
loan modifications, and
paths treatment changes at
• Customized debt segment level
restructuring plans
for select customer
• Tagging and monitoring
of population on the
segments CARES Act or other relief
• Contact strategy programs
adjustment - digital
versus outbound calling
• Monitor call volume and
complaints
• Delinquency stress-
testing scenarios to
• Increased reporting/
monitoring frequency
assess collection volume
• Workforce optimization
based on adjusted
strategies
• Stress scenarios for auto
lease return rates and
accumulation for better
resource planning
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and capital iterations in an agile reporting at segment level

planning fashion; run various - by region, type ofloan,
scenarios and estímate and so forth
impact on revenue and • Reporting impact of
losses rating downgrades and
• Reserve estimation higher draws on balances/
under generally reserves
accepted accounting • Attribution analysis and
principies and reporting on change in
comparison with current reserve quarter-over-
expected credit losses quarter
(CECL) ifrequired
• Analytical structure
to follow a consistent
approach quarter-over-
quarter for reserve
overlay

A. Reset acquisition strategies with

tightening of cutoffs, limit adjustments, and
expanded use of traditional and alternative
data
The current crisis calls for review of the existing acquisition policies, strategies, and cutoffs to
manage emerging risks and provide ongoing credit to customers. The actions by banks during
these times will inspire future costumer loyalties, help gain market share, and mitigate
reputational risk.

Optimize attribute cutoffs:

Origination cutoffs should be adjusted to ensure acceptable levels of risk from new originations.

What-if scenario analyses to revise origination score/attribute cutoffs based on risk-return

trade-off, aimed at controlling losses while ensuring acceptable approval rate
Reduce initial credit limit assignment (for revolving line of credit)

Additional attributes can be used to tighten the strategy along with stricter employment and
income verification.

Refine segmentation:

Create granular risk tiers for origination and monitoring through:

Expanded use of traditional (credit bureau and internal attributes) and/or alternative data to
identify pockets where new originations would still be viable based on the risk-reward balance
Monitor and report on new volumes at segment level based on revised acquisition strategies
Focused monitoring by region, considering the transmission rate and response to relaxed
public movement restrictions. Mobility and transmission indices such as the Google mobility
index or Rt index, which captures the R-naught of transmission by region are also useful

Data Enrichment:

Risk scores along with additional data attributes such as payments, debt-to-income ratio, net
cash flow variables, and so forth can improve targeting
 Cash flow variables derived from customer-level income and expenses are forward-looking and
better predictors of ability to pay in a crisis
Alternative data from utilities, rental payments, public records, and alternative lending like
payday, rent-to-own, small-dollar loans, and so on can better identify pockets with a lack of
willingness and/or ability to pay
Traditional delinquency bureau variables and their derivatives, which are typically used in
acquisition, should be used with caution because they may be tainted by the payment
deferrals, forbearance, and loan modification programs

Monitoring for early warning signals and corrective actions:

Shorter-term performance window models can be used to trigger early warning signals on the new
volume and existing book to exercise early lifecycle controls.

Iterative evaluation:

The above should be coupled with a comprehensive and semi-automated what-if scenario analysis
framework to estimate the P&L impact of strategy changes in alternative scenarios, which would
help iteratively fine-tune acquisition strategies based on risk appetite and portfolio growth
considerations. The loss expectations in the P&L impact can be derived by repurposing banks'
existing forward-looking stress-test models.

Overall, acquisition strategies should be guided by what-if analyses, sensitivity testing, and the
portfolio risk appetite. It would require iterative fine-tuning in an agile framework to counter
emerging risks and increase the risk-adjusted margins and profitability.

Banks should also ensure a reasonable oversight and governance from the model risk function
when new attributes are being used in acquisition decisions. Legal and compliance counsel should
also be kept in the loop on evolving acquisition strategies to ensure that they comply with fair
lending practices.

Case Study 1: A large US consumer bank

Genpact supported enhancement of a suite of customer acquisition strategies for the bank as a
tightening measure in the COVID 19 situation. This includes adjusting auto-decision rules to
reduce referral queueing and wait time, resetting customer credit limits for new and existing
accounts, and adjusting approval thresholds for new applications. Segmentation, scenario, and
iterative what-if analyses are being performed to come up with quick and easy-to-implement
recommendations.

Overall, acquisition strategies should be guided by what-if analyses, sensitivity testing, and the
portfolio risk appetite. It would require iterative fine-tuning in an agile framework to counter
emerging risks and increase the risk-adjusted margins and profitability.

Banks should also ensure a reasonable oversight and governance from the model risk function
when new attributes are being used in acquisition decisions. Legal and compliance counsel should
also be kept in the loop on evolving acquisition strategies to ensure that they comply with fair
lending practices.
B. Refresh account management strategies
with tighter monitoring, line optimization,C
and account treatment
In the evolving crisis, risk managers should proactively engage in account management to
continually monitor high-risk concentrations in their portfolios and effectively mitigate risk.
Managing revolving-line-of-credit products becomes especially relevant in this regard because
there are several levers to mitigate risk in such portfolios.

Enhanced monitoring and reporting:

More frequent risk monitoring (daily/weekly) with additional KPIs would be required to augment
the business as usual risk reporting in most banks. These KPIs may include but not be limited to
revolver utilization trends, credit line trends, active versus inactive account trends, COVID 19 call
volumes, payment deferral requests, loss mitigation trends, and so forth. Such enhanced reporting
can be categorized by products and into finer customer and geographic segments, especially
taking into account the transmission in a region. This will help banks identify segments that are
contributing to a disproportionate share of losses and guide strategy-tightening measures.

Credit line optimization:

Prompt line-decrease actions for high-risk pockets based on early warning signals, aimed at
reducing future “bad spend" through targeted actions
Increase cutoffs for line increases based on revised risk identification and tiering
Reoptimize increase amounts and frequency

Inactive account treatment:

Inactive account line reduction and closure strategies also need to be reevaluated to reduce
exposure and limit potential losses. During a crisis, inactive accounts also tend to draw and default
as other sources of debt are restricted.

Risk management in a new/young portfolio:

The account management of a young portfolio poses additional challenges for banks because they
may see an increase in early delinquency and payment deferral requests during the pandemic, and
there is not enough performance history in such portfolios to make informed data-driven
decisions. Young portfolios carry the risk of adverse selection, especially with new product
launches. Risk managers should creatively use bureau and alternative data sources to address this
issue. Data enrichment strategy for account management can include:

Use of underutilized attributes like debt-to-income ratio, total debt, recent inquiries, payment
variables, employment types, and so forth
Use of shorter-term performances like utilization and payments on active revolving trade in the
past three months for early warning triggers
Use of debt-related derogatory public records to supplement tradeline data
Use of alternative lending payment information and financial payment information from
utilities, telecom, property records, and so on to enrich traditional data streams

Credit bureau data, however, must be used with caution during the current crisis given the tainted
delinquency, charge-off, and loan modification variables. This is especially true given the varying
treatment by banks to support customers in financial stress through forbearance and payment
deferrals.
The underlying success factor for effective account management is to identify customers facing
temporary economic hardship as compared to the ones facing structural impairment in their ability
to pay. Such differentiation can be achieved using additional attributes like the debt to income
ratio, payment velocity index, and/or by creating ability to pay scores from alternative and
unstructured data collected from COVID 19 calls and payment deferral requests.

Case Study 2: A leading US bank

We developed easy-to-consume trend and comparative portfolio analysis dashboards leveraging

account-level data of ~90 of the bank's portfolios. Key metrics focused on exposure, utilization,
delinquency roll rates, and loss mitigation program enrollments including potential KPI impact
because of the CARES Act. Leveraging big data platforms and cloud-based business intelligence
tools, web-browser based reports are being built for risk managers and leadership reviews.

C. Reassess collection strategies with a focus

on enhanced monitoring, updated
segmentation, and treatment optimization
The collection and recovery function sometimes takes a back seat in an expanding economic
environment because wage growth and decreasing unemployment put more focus on growth and
new originations. Given that the last recession was more structural in nature and required
enhancement in approaches for capital stress testing and reserving, collections in the banking
space did not evolve as much as it should have in advanced analytics and technology adoption.
The current crisis has returned the spotlight to this area. Data analytics, including monitoring,
strategy, and model enhancements can drive informed collection actions during these times.

The level of forbearance and loan extension requests seen in the industry has been unprecedented
in this crisis. With its economic package, the government has provided temporary relief to
customers and deferred the impact on rising delinquency and loss realization. There is no
straightforward approach to measuring the impact of government relief programs on charge-offs.
It would thus be critical for banks to monitor early delinquencies, use finer segmentation to
identify emerging high-risk concentration, and apply treatment that would maximize collection
dollars.

Monitoring:

The population impacted by COVID 19 and deferrals/extensions provided through government or

bank relief programs need to be tagged and updated in the data on an ongoing basis. Granular
performance monitoring by region, risk bands, employment type, and so on would be required to
understand high-risk concentrations and identify early warning signals. These signals can also be
generated using an expanded set of bureau variables as well as internal and alternative data
attributes. Some of these attributes have been referenced as data enrichment in the acquisition
strategy section of this paper.

Updated segmentation and collections strategies:

Early warning signals at a granular level should inform collections strategies as the impact of the
pandemic evolves.

Pre-delinquent actions: Identify pre-delinquent segments that are likely to move to

delinquency
• and use digital channels for payment reminders. The population on deferment
 plans needs close monitoring and assessment, including potential extension of relief term if
there is a possibility for repayment when the situation improves. On the other hand, if the
customer was already displaying financial difficulties, focused recovery efforts would be
required instead of delaying further
CONT
Self-cure: Self-cure segment identification on early delinquent accounts is important to limit
resource diversion, increase collectors' capacity, and prioritize collection resources on accounts
that need agent contact and offers. Bureau data and alternative data in machine learning
models can fine-tune collections strategies to identify accounts that require no intervention to
softer automated interventions on their path to self-cure
Late stage delinquencies: Late-stage collection analytics and modeling is required to identify
segments of customers who are more likely to pay based on their ability-to-pay and willing-to-
pay scores. Such analytics can use machine-learning-based approaches to predict payment
projections and estimate the value at risk for each customer. This can then be paired with
customer response models for various contact strategies and offers

Treatment:

Treatment optimization and response to treatment is another key area of collection analytics that
should leverage both structured and unstructured data to maximize recovery and minimize cost.
As more granular segmentation is developed to better understand evolving customer behavior and
emerging risks, treatment strategies should be personalized at a micro-segment level.

The key objective here is to arrive at the best treatment based on customer probability of
response and banks' need for minimizing charge-offs and cost. This can often turn out to be a
nonlinear optimization problem with several constraints.

Enhanced monitoring, granular segmentation, and personalized dynamic treatment optimization

are essential for dealing with the challenges posed by the pandemic and the evolving situation.
Further, banks can explore expanded use of internal, bureau, and alternative data to refine
collection strategies in the COVID 19 situation.

Case Study 3: A global auto finance leader

We set up comprehensive reporting for accounts on payment extension/deferral as part of the

relief program. We also segmented the account base by region and portfolio/bureau performance
to identify high-risk pockets that may turn delinquent at the end of the deferral period. Then,
developed proactive collection strategies for pre-delinquent and early delinquent accounts using
finer segmentation and customer behavior scorecards.

D. Need for agility in the reserving and

capital estimation process with focus on
model adjustments and overlays
Reserving and capital estimation, while not part of the customer credit lifecycle, is critical to the
financial health of a banking institution. The current crisis puts added focus on these activities as
the regulatory programs of comprehensive capital analysis and review (CCAR), current expected
credit losses (CECL) and the international financial reporting standard 9 (IFRS 9) were designed to
make the banking and financial services organizations resilient in the face of emerging economic CON
crises. Like every crisis, the current pandemic has also humbled quants and risk managers as they
find model-driven expected credit loss forecasts to be at unprecedented levels, given the
magnitude and speed at which the macroeconomic situation has deteriorated.

Supervisory agencies have recognized the implication of the crisis on banks and its customers and
provided concessions in the spirit of keeping day-to-day operations running. Relief has been
provided by way of relaxation of timelines for regulatory reporting, regulatory examination
timelines, CECL adoption, and adjustment of the supervisory approach for aspects of loan
modification, among others.

Though the above relief measures are timely and have been well received by banks, the current
crisis has created a need for agility, quick turnaround, and automated calculation of expected
credit losses under various economic scenarios. Given that model predictions by most of the banks
are falling outside reasonable range, there is a need to come up with a structure for estimating
overlays and management adjustments that are stable quarter-over-quarter, in line with the
industry response and not overly conservative or benign.

Banks can create a menu of scenario and adjustment approaches and choose those that work best
for their customer profile and risk concentrations. These approaches can vary in complexity and
granularity based on richness of data, existing modeling methodology, and portfolio size. A list of
methods that can be evaluated to adjust expected credit loss models appears below.

Output adjustment:

Absolute capping and flooring of predicted rates based on a historical maximum and minimum,
along with applying +/- two standard deviation sensitivity. Data from the last financial crisis
and/or data capturing the impact of hurricanes Harvey and Irma, if available and applicable
with the geographic footprint, can be used for estimating the historical maximum and
minimum
Capping and flooring based on the rate of change quarter-over-quarter in the current
prediction vis-à-vis historical experience

Input adjustment:

Use of regional macro-economic variables as opposed to national indices in the models. Use of
smoothing transformations and binned macro-economic variables to estimate adjustment
In-house macro-economic scenario generation based on the regional footprint, mobility index,
and transmission rate
Identify double counting in loan level attributes and existing top-level adjustments in the
models
Bake in business expectation on the severity of rating downgrade, additional draws, and its
impact on the expected credit losses

Given the increased frequency of model adjustments and overlays to these Tier – 1 models, there is
a need for the model risk management (MRM) function to provide an effective challenge through
a timely review of the adjustments made by the first line of defense. Immediate interventions
from model risk can be summarized by the following steps:

Model inventory heat map based on risk rating and risk tier to prioritize MRM efforts for
oversight
Assessment of overlays based on the methodology used as well as magnitude, stability, and
sensitivity over time
 Evaluation of ongoing performance monitoring for breaches and root cause analysis
Benchmarking results with industry numbers for reserves, capital, and default rates to assess
the magnitude and directionality of the adjustment

In a nutshell, the need of the hour is to develop the capability of rapid forecasting, with
implementation runs based on various external and internally developed scenarios and
sensitivities in the portfolio. This, accompanied by a well-documented and thought-through
attributional analysis that explains quarter-over-quarter change in loss forecast, would bring
confidence in reporting not only to the regulators and auditors, but also to the street.

Case Study 4: A US CCAR SR 15-19 Bank

We provided end-to-end support for the COVID 19-related impact assessment and overlay
estimation for the bank. We analyzed the sensitivity of IFRS 9 and CECL reserves to Moody’s
provided and internally designed scenarios. We also performed reserve impact comparison and
driver identification analysis under COVID 19 versus business as usual scenarios for IFRS9 and
CECL. Finally, we consolidated the impacts of uncertainty driven by macroeconomic scenarios,
rating downgrades and additional draws, and estimated additional reserves required across
portfolios.

Conclusion
The COVID-19 pandemic has created great uncertainty regarding the future of the economy, and
its scale of impact will depend on the intensity and duration of the underlying public health crisis.
While the government and supervisory agencies are providing support and relief, banks need to
rise to the occasion and proactively implement best practices in credit risk management to
navigate through these times. These interventions must be thought through the stages of credit
lifecycle to keep them dynamic and interconnected in nature based on the evolving risk landscape.

The banking organizations that respond to today's challenges with speed and flexibility, while
keeping in mind customer needs during these unforeseen times, are the ones that would be top-of
mind for customers as they think of their credit needs in the future.

Equally, keeping an eye on the medium- and long-term capability enhancements necessary to best
serve customers in the post pandemic world is imperative.

Authors

Rafic Fahs

Senior Advisor, Risk and Compliance Advisory Council

Former Chief Model Risk Officer, Santander US

Rafic.fahs@genpact.com

Jyotiska Mitra

Head, Banking and Capital Markets, Advanced Analytics

Jyotiska.mitra@genpact.com

Mohammad Amir Sarosh

AVP, Banking and Capital Markets, Advanced Analytics

Mohammadamir.sarosh@genpact.com

APPENDIX
Government actions to mitigate the impact of the economic crisis

The US congress has responded to the resulting economic hardship by passing the CARES Act, the
largest ever peacetime stimulus package, which includes:

Disaster relief for state and local governments

Direct funding to hospitals along with assistance for doctors and nurses, and for stockpiling of
medical supplies
Financial assistance to distressed and struggling businesses
Small business loans through its payment protection program
Direct payment to and unemployment benefits for most Americans

Regulatory response to provide relief for banks and support to the market

Supervisory agencies like the Federal Reserve Board (FRB), the Office of the Comptroller of the
Currency, the Federal Deposit Insurance Corporation, and the Consumer Financial Protection
Bureau have also recognized the impact of the crisis on banks and its customers and provided
concessions in the spirit of keeping core day-to-day operations running. The key relief measures
include:

Relaxation in timelines

Additional time for adoption of the CECL framework and extension of regulatory capital
transition
Extended deadlines for various regulatory report submissions like call report, FR Y-9C, and FR
Y-11
A 90-day extension for remediating the existing supervisory findings

Relaxation in supervisory activities

The FRB ceased its examination activity for financial institutions with less than $100 billion in
assets
Delayed examination activities for financial institutions with more than $100 billion in assets
Loan modifications related to COVID 19 are not to be categorized as troubled debt restructures
(TDRs)

The FRB has also taken several steps to support liquidity and credit generation through actions
such as lowering the interest rate, purchasing government and government-sponsored enterprise
securities, and re-establishing programs on liquidity and credit support from the last financial
crisis.