Luxembourg banks insufficient at assessing credit risk: survey

Luxembourg’s banking sector is ill-equipped to identify business risks at an early stage and is in danger of losing returns if the sector undergoes a credit crisis.

The warning comes from a white paper written by UK fintech Galytic, entitled Banks Must Act on Their Early Warning Systems or Risk RoE Downturn.

The paper contends that banks’ current risk systems are too reliant on backwards-looking indicators with high false positives. Furthermore, they do not make enough use of external data and fall back on internal data held in silos.

These risk management methods and data sources are outdated at a time of impending crisis for the banking sector, states the report.

It cites macro factors such as inflationary pressures, pandemics, climate change, geopolitical risk and supply chain disruption which could impact businesses in unexpected ways.

High-profile defaults such as Wirecard, Thomas Cook, NMC Healthcare and Hertz are held up as examples where banks were to slow to act.

“Banks have a limited window of opportunity to adapt and respond to the emerging scenarios,” states the report.

“Although large systematic shocks are unpredictable, it is clear that the speed at which banks are able to react to these events can have a huge effect on the ability actively manage the lending book and reduce any negative impact,” it adds.

The report also cites regulatory pressures with the European Central Bank highlighting the huge variation in the quality of banks’ early warning systems, as well as competition from non-bank lenders, many of which are using more sophisticated credit risk systems.

“Risk aversion along is not a strategy,” states the paper. “Upgrading early warning systems is crucial for corporate banks to drive their competitive advantage and improve returns.”

PwC Luxembourg invited Galytix to address the grand duchy’s banking sector. Matt Moran, partner and deputy advisory lead, M&A head of insurance at PwC Luxembourg said banks face “pressure from all sides, from shareholders, regulators and salespeople”.

Galytix chief executive Raj Abrol said: “The coming crisis will not be a liquidity crisis but a credit crisis. In the UK, more than 5,000 business failures have been recorded, the highest level since 1960. The European Central Bank has asked the banks to prepare themselves,” he said.

“It is impossible for a bank to identify all its risky customers before they default,” concludes the white paper. “However, it is possible for banks to establish a prudent system and processes to identify and monitor a significantly higher proportion of accounts with default potential.”