Credit card loss forecasting: Some lessons from COVID

Abstract

AbstractModels developed by banks to forecast losses in their credit card portfolios have generally performed poorly during the COVID‐19 pandemic, particularly in 2020, when large forecast errors were observed at many banks. In this study, we attempt to understand the source of this error and explore ways to improve model fit. We use account‐level monthly performance data from the largest credit card banks in the U.S. between 2008 and 2018 to build models that mimic the typical model design employed by large banks to forecast credit card losses. We then fit these on data from 2019 to 2021. We find that COVID‐period model errors can be reduced significantly through two simple modifications: (1) including measures of the macroeconomic environment beyond indicators of the labor market, which served as the primary macro drivers used in many pre‐pandemic models and (2) adjusting macro drivers to capture persistent/sustained changes, as opposed to temporary volatility in these variables. These model improvements, we find, can be achieved without a significant reduction in model performance for the pre‐COVID period, including the Great Recession. Moreover, in broadening the set of macro influences and capturing sustained changes, we believe models can be made more robust to future downturns, which may bear little resemblance to past recessions.