WASHINGTON - A top Treasury Department official said this week that regulators need to push banks to back up advanced risk management techniques with old-fashioned, case-by-case credit analysis.
Peter Fisher, the under secretary for domestic finance, said lenders were lulled to inattention by favorable economic conditions in the 1990s and largely abandoned the "dirty-fingernail business of credit analysis." They have become too reliant on risk models and other formulas to measure their credit exposure, he said, and are paying for it with the recent string of high-profile corporate defaults.
In an interview Thursday, Mr. Fisher said that as regulators rewrite the Basel Accord, which sets international capital requirements, they must remind bankers that its complex risk models are no substitute for hard-nosed credit assessments of individual borrowers.
"The challenge is going to be to say: 'Yes, it is great we are defining the models in the risk-based capital regime, but it is pretty elemental to remind people that regulatory capital is about minimums. You, the banker, had better be doing your credit work to decide which borrower deserves which sort of credit grade and how you price it.' "
He noted that large-scale defaults are on the rise, and said they can be traced to a breakdown in basic credit judgment.
"Each year we are seeing more and more of these problems coming from individual credit judgment problems," he said. Though several years ago it may have been safe to base a credit decision on the strength of a particular business sector, he added, "now it matters which energy company you hold the debt of."
In the interview, Mr. Fisher elaborated on remarks he made Wednesday at a symposium sponsored by the Federal Deposit Insurance Corp.
In his speech that day he called on regulators to help reverse the trend toward overreliance on formulaic, market-based credit decisions. "The challenge for policymakers over the coming five years … is recreating credit culture and the grubby business of credit analysis," he said.
As the former head of the Federal Reserve System's open market operations, Mr. Fisher told the audience, he recognizes the usefulness of complex models and other portfolio management tools. However, he said, regulators now need to wean banks away from over-dependence on them.
"Over the past five years we have been learning the importance of differentiating between [borrowers] with real cash flows and those without, between those that have honestly and transparently disclosed their risks and those that have not."
Mr. Fisher said that during the economic boom of the 1990s banks were relatively successful in basing individual credit judgments on "rough rules of thumb for spreads and for credit rating categories."
This led to today's environment in which "we outsource to someone else the judgment of whether I should have [a loan] in my portfolio … and I put my credit judgement on autopilot."
These practices, he said, "have come home to haunt us in the past five years."
Though the economic landscape has shifted beneath them, he said, bankers have stood still. The result is that they have persisted in identifying problems as "market events" when they really reflected poor credit judgment.
He said that episodes such as the Asian crisis of 1997, the near collapse of hedge fund Long-Term Capital Management in 1998, and the more recent corporate defaults "have been mistakenly, in my view, seen through the prism of 'market risk,' as if they were exogenous shocks.
"I think they are better understood as a series of credit events in which the quality of certain borrowers came to be better understood."
