Measuring Consumer Credit Risk for a Large UK Retail Bank

The Situation

The current unprecedented level of unsecured consumer borrowing has created concern amongst lending institutions that a sudden and severe economic shock, such as an interest rate rise, and its concomitant impact on GDP and unemployment, could result in a significant increase in defaults on unsecured borrowing of a magnitude last seen during the UK recession of the early 1990s.

NERA's Role

To understand the relationship between the performance of the UK economy and credit card defaults, NERA was engaged by one of the largest UK retail banks to investigate the relationship between macroeconomic variables and charge-offs on a credit card portfolio held by the bank. The bank sought to reinsure tranches of its credit card portfolio and wanted an independent assessment of the riskiness, and hence, benchmark price, of a reinsurance transaction.

The Result

The NERA team delivered an independent assessment of the riskiness of the credit card book which provided analysis to support a transaction to reinsure tranches of the portfolio. This analysis provided an independent quantification and analysis of the credit risk that the client was aiming to reinsure. It thus underpinned the proposed transaction through: providing the client with an independent measure of the riskiness of its credit card portfolio; providing the client with an assessment of credit quality under different scenarios for the UK credit card market and UK economy; and providing reinsurers with independent analysis of the value of the credit card portfolio and, hence, the value of the proposed transaction.