During his speech at the ECB’s 2010 Central Banking Conference, Jean-Claude Trichet, President of the ECB, said “As a policy-maker during the crisis, I found the available models of limited help. In fact, I would go further: in the face of the crisis, we felt abandoned by conventional tools.” [1] The subprime crisis was nearly over and the most important lesson learned was not to rely on a single tool, methodology or paradigm.
Since the subprime crisis happened the European Central Bank has done a lot in order to reinforce the bank’s capital, along with an increasing … in regulations. After more than ten years, another and even bigger crisis is shaking the financial system. During the 2008/2009 the shock was asymmetric, its epicenter was in US, and then it propagates since losing power all over the world. The COVID-19 one is somehow symmetric, since it involves nearly everyone, from common people to big corporation, from local structures to interstates governments. Everyone has been hit strongly. The economy is in PAUSE, markets agents are both betting on a V- or L-shaped recession. Best case scenario, is that the economy is in pause and we will get back soon to a normal. Worse scenario, is that the economy will go into recession which will last for years. In the meanwhile, job losses, bankruptcies and increased defaults remain a likely inevitability. And so now, during the COVID-19 crisis, those who have faith in the model will probably discovered soon that they have some weakness, because the COVID-19 crisis is totally different from the previous one. As all crisis are. Mr Trichet said “In the absence of clear guidance from existing analytical frameworks, policy-makers had to place particular reliance on our experience. Judgement and experience inevitably played a key role.”. Analytics models can help, but since the current crisis is something unique and never experienced so far, sooner or later these problems will come up. Default rates experienced during the 2008/9 credit crisis can function as a benchmark, but this crisis is not similar to the previous one. That doesn’t mean we’ll stop using models. They can still rank ordering, but maybe the probability to default will vary significant and must be calibrate to a new scenario.
Models will be inaccurate, data will be incomplete to accurate predict during an unexpected economic downturn. But here’s one thing we can deduct from historical experience: investing in infrastructure investments to create an integrated model development, deployment, validation and decisioning ecosystem will facilitate the process of developing and deployment of new models, which can be tested on new scenarios and can help the risk managers in navigating the current period uncertainty, because “All models are wrong, but some are useful” [2].
[1] Speech by Jean-Claude Trichet, President of the ECB, 18 November 2010,
Reflections on the nature of monetary policy non-standard measures and finance theory,
Accessible at: https://www.ecb.europa.eu/press/key/date/2010/html/sp101118.en.html
[2] George Box (1976), “Science and statistics”, Journal of the American Statistical Association
