Risk Management & Analytics: What financial modelers can learn from MoviePass when implementing CECL

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What financial modelers can learn from MoviePass when implementing CECL

If you have followed the news about MoviePass and its recent financial downfall, you may have read about declining stock prices and angry customers, and made a mental note about what not to do in business. However, there is one critical but less obvious lesson to learn from the MoviePass pandemonium – and it is one that just might keep your financial institution from going down the wrong CECL road.

When looking at MoviePass’ failure to meet its customer commitment, one has to consider that its business leaders based its subscription model and pricing plan on statistical estimates, as any good business would do. However, in this case, it seems clear that MoviePass did not accurately forecast subscriber use, which, in turn, caused the company to underestimate projected costs and losses. In simple terms, MoviePass may have based its business model and subscription product around bad statistical sampling and averages from that sample when deciding its cost/pricing.

If MoviePass assumed that the average subscriber went to three movies per month, then an estimate based on averages would simply multiply the total number of overall moviegoers in a given month by the average number of movies attended by customers in a given month. It sounds straightforward but unfortunately, not every moviegoer is the same. Millennial Mike, for instance, might attend seven movies per month while Baby Boomer Bob only goes to one or two. MoviePass’ forecast likely did not take into account user bias, whereby more millennials would purchase the subscription and take full advantage.

The lesson learned is that when it comes to forecasting, idiosyncrasies matter. In the context of CECL, a financial institution may use an “average” approach to estimate losses based on historical performance, and perhaps it makes sense if its portfolio is rather homogenous. However, it is important to keep in mind that once an institution chooses its method for calculating losses, it will need to stick with that model for years to come. It is important for institutions to consider whether the average approach will be the right approach in five years. Will your portfolio behavior change? Will the local economy change? Will an “average” of historical losses enable your institution to set aside the right amount of capital? Or, will your institution end up over or understating losses?

Next time you head to the movies, give a second thought to your CECL modeling methodology. That is, if MoviePass will let you in to the movie in the first place.

To assess whether your model will be sufficient to address nuanced portfolios, please reach out to Atul Nepal anepal@mviewfs.com.

Senate confirms Clarida to Federal Reserve, two others remain in limbo

The Senate voted Tuesday to confirm Richard Clarida to serve a four-year term as vice chairman of the Federal Reserve Board of Governors and a 14-year term as a member.

The Senate voted 69-26 to confirm Clarida as vice chairman, with one Republican, Sen. Rand Paul, R-KY, opposing the nomination. Clarida’s nomination to serve as a Federal Reserve governor was confirmed through a voice vote.

His nomination drew criticism from Sen. Sherrod Brown, D-Ohio, ranking member on the Senate Banking Committee, who said Clarida did not sufficiently answer committee members’ questions during his confirmation hearing and afterwards in responses for the record.

“He failed to provide the committee [with] meaningful insight into his views,” Brown said in a floor speech before the full Senate voted. He said the responses the committee got were “pretty much identical” to another Federal Reserve nominee, Michelle Bowman.

Brown added that he was “not confident” Clarida would protect taxpayers and homeowners from the next financial crisis.

Clarida testified before the banking panel in May alongside Bowman, but Bowman’s nomination has not yet been considered by the full Senate.

A third nominee, Marvin Goodfriend, who testified before the committee in January, also hasn’t been considered by the full Senate. The Democrats on the committee unanimously opposed his nomination and Paul indicated that he would also vote “no.”

Read more: American Banker

Big banks should increase capital now before the next downturn

Current economic growth and record high bank earnings justify U.S. bank regulators requiring systemically important banks to start allocating more capital to sustain unexpected losses that result when an economic or market downturn occurs. In 2010, the Basel Committee on Banking Supervision (BCBS), the international standards setter for banks, included a countercyclical capital buffer as part of the global capital and liquidity framework, Basel III. The BCBS recommends that regulators trigger the countercyclical buffer for banks in their jurisdiction when countries are in an expansionary part of the credit cycle and that they decrease the buffer when an economy is slowing down.

The purpose of the countercyclical capital buffer is “to ensure that banking sector capital requirements take account of the macro-financial environment in which banks operate. Its primary objective is to use a buffer of capital to achieve the broader macroprudential goal of protecting the banking sector from periods of excess aggregate credit growth that have often been associated with the build-up of system-wide risk.” Importantly, due to its countercyclical nature, “the countercyclical capital buffer regime may also help to lean against the build-up phase of the credit cycle in the first place. In downturns, the regime should help to reduce the risk that the supply of credit will be constrained by regulatory capital requirements that could undermine the performance of the real economy and result in additional credit losses in the banking system.”

Read more: Forbes

Better regulations needed for competitive banking system to work, paper says

In most business environments, economists see competition as an unqualified force for good, driving companies toward efficiency and innovation and ultimately bringing more affordable, higher-quality products and services to consumers.

In the paper, economists Dean Corbae, of the University of Wisconsin-Madison, and Ross Levine, of the University of California at Berkeley, found that while intense competition among banks indeed spurs greater efficiency, it also tends to squeeze profit margins and encourage riskier investments. That leaves banks more fragile—an outcome that can have devastating consequences when the effects ripple across the financial system.

But the authors made a second observation that could prove timely as the Fed works to fine-tune financial regulations a decade after the 2008 crisis: Policy makers can avoid the “fragility costs” of competition by enhancing bank governance and tightening leverage requirements to make banks hold more equity for every dollar they lend out or invest.

“These findings highlight the enormous welfare benefits of legal and regulatory reforms that improve the incentives of bank decision makers,” Messrs. Corbae and Levine wrote. “Such reforms improve bank efficiency, reduce bank fragility, allow for a more competitive banking system without increasing bank fragility, and bolster the effectiveness of capital requirements.”

Read more: Wall Street Journal

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