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Banks Misjudge Chance of Borrower Default on ‘Hard’ Forecasting

Banks are misjudging the likelihood of default on their loans, a measure used to calculate how much capital they need through risk weightings, by an average of 54 percent, according to analysts at Barclays Plc. (BARC)

The banks’ forecasts compared with actual defaults are overstated by about 35 percent, the research, which analyzed the predictions of 19 lenders including Lloyds Banking Group Plc (LLOY), HSBC Holdings Plc (HSBA), National Australia Bank Ltd. and Danske Bank A/S (DANSKE), found.

“With the average absolute ‘error’ over 50 percent, it’s clear that accurate forecasting is hard, and this adds another layer of uncertainty to the resulting” risk-weighted assets, analysts led by Simon Samuels wrote in a note to clients today.

Global regulators in January criticized the way banks disclose how they calculate the amount of capital to hold against trading assets, finding “substantial variations” in the lenders’ risk assessments.

The quality of public information is “insufficient to allow investors and other interested parties to assess how much of the variation reflects differing levels of actual risk and how much is a result of other factors,” the Basel Committee on Banking Supervision said in a report.

“Most of the time banks’ actual” probabilities of default “are lower than forecast, suggesting a degree of conservatism, which is good,” Barclays said. “However, the forecasting ‘errors’ can be massive, which raises questions over both the predictability and hence meaningfulness of the resulting RWAs.”

To contact the reporter on this story: Howard Mustoe in London at hmustoe@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

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