Those engaged in social science – a category that includes most forms of risk modeling – are often accused of being bad scientists. The accusations generally come from physical scientists, who enjoy the luxury of access to repeatable experiments with few real-world consequences. However, most would rightly frown on a bank offering loans to those who can’t afford them just to gather data to improve their models for future use.
When banks manage risk, conservatism is a virtue. We, as citizens, want banks to hold slightly more capital than strictly necessary and to make, at the margin, more provisions for potential loan losses. Moreover, we want them to be generally cautious in their underwriting.
For banks, one of the more onerous aspects of regulatory supervision is documentation. Regulators demand detailed descriptions of the models being used and banks have responded by the bucket-load.
In recent weeks, public debate in the banking industry has centered on loosening stress testing rules for the largest banks. Democrats in Congress have discussed the prospect of removing the burden of Comprehensive Capital Analysis and Review (CCAR) for all banks with assets under $250 billion. Treasury Secretary Steven Mnuchin has gone further, suggesting that banks with assets between $10 billion and $50 billion be freed from all regulatory stress test scrutiny.