Improve the quality of risk assessment with the Nowcasting tool

Products 28 September 2022

The world has been undergoing a period of economic, environmental, social, health and humanitarian crisis for more than two years now and emergencies continue to add-up. The impact of this global crisis are felt on individuals, governments, enterprises, banks, the planet and on the society in general. In this context, uncertainties for SMEs consist especially in a decline in their reliability, which results in an ever-growing complexity of access to credit and in an extension of payment times.

Why is credit risk important?

A greater institutional and corporate interest for the notion of “credit risk” begins in 2008 with the failure of the Washington Mutuals and Lehman Brothers banks, event that brought the whole world to a protracted and painful recession. The main cause of these bankruptcies were the mispriced abilities of their clients to repay their debts. After this long crisis period, the creditworthiness has progressively become more and more essential, both from a practical and compliance point of view, in order to ensure that the debtors are able to pay off their financial obligations.

Despite the fact that the topic of creditworthiness is addressed more seriously, the financial market is often confronted with challenges relative to the low-frequency of companies’ information (due to annual and infra-annual balance sheets), with obvious evaluation delays of at least 6-8 months, if not of an entire year, and to a total lack of data for most small businesses – as well as for large companies – because of regulatory differences among individual countries.

In order to remedy these issues, we work more and more to increase technological capabilities, to raise the amount of data, as well as their frequency, with the aim of obtaining information of ever-increasing value.

In this context fits the innovative proposal of modefinance, a Fintech company of the Teamsystem Group, specialized in the development of Artificial Intelligence solutions for credit risk analysis and management, that developed a proprietary nowcasting model.

A real-time prospective

With the notion “nowcasting”, introduced by the science of meteorology, we denote the type of data in real time that allow to make short-term predictions, which makes the model more accurate compared to traditional, long-term predictive algorithms, which are based on balance sheets filed even one year before. Moreover, a further competitive advantage of nowcasting is given by the use of big data that have quicker and more sophisticated calculating capabilities.

The value of nowcasting has been experienced first-hand since 2020 by all of us, when the global financial market crashed as a consequence of the Covid-19 pandemic lockdown. Since the economic and financial situation was changing from week to week, traditional tools were not responsive enough to predict how would evolve the economic conditions in the coming weeks. Therefore, nowcasting and the use of Artificial Intelligence and Machine Learning tools have been useful to detect inflation, unemployment, migration flows developments, and many other factors that emerged as a consequence of the pandemic, as well as of the conflict in Ukraine. 

Reliable and real-time data: modefinance’s Nowcasting

modefinance, a Fintech native company specialized in the evaluation of companies’ and banks’ creditworthiness, and in the development of Artificial Intelligence solutions for the credit risk analysis and management, took a further step in the evolution of our technological offer to SMEs and financial institutions, by launching our proprietary Nowcasting model.

This model has as its purpose the real-time assessment of any Italian enterprise’s economic and financial riskiness, by comparing the evaluated company’s trend and its corresponding micro-sector.

Furthermore, our Nowcasting model results in two useful outputs for the user. That is, an alphanumeric evaluation (score), which is able to point out, in real time, the subject’s trend and all the sudden changes that could impact it – both in the case of improvements and deteriorations – and the Nowcasting Index that represents, also in real time, the riskiness trend of the enterprise or enterprises under analysis.

Useful tools in times of crisis: the Nowcasting model

In addition to having developed the model, our interdisciplinary teams (composed of financial, Fintech and rating analysts) put in relation the Nowcasting Index and the MORE score – the heart of modefinance’s assessment methodology – in order to understand whether between these two elements there is any positive correlation.

Below, we report an analysis in which our analysts considered a sample of Italian SMEs with a turnover lower than €50 million belonging to three sectors of major importance for the historical moment we are living in: energy sector, construction sector and foodservice sector. The period taken into account goes from 1 January 2020 to the end of June 2022. 

In the graph above, Nowcasting indexes aggregated by MORE rating band have been compared. Therefore, companies are divided as follows:

Healthy (rating AAA – AA – A)

Balanced (rating BBB – BB)

Vulnerable (rating B – CCC)

Risky (rating CC – C – D).

The movement of the curves that represent the indexes by rating band depicts how the index is higher for healthy enterprises, to a smaller extent for the balanced ones, until reaching less advantageous results for risky companies, from which it can be deduced that it exist a strong correlation between the MORE Score and the Nowcasting Index.

Eventually, given the relation between the MORE Score and the Nowcasting Index, the predictive power of the index has been measured by discriminating defaulted companies from the non-defaulted ones. After a series of technical evaluations, modefinance’s Nowcasting model revealed to have an excellent predictive capacity, as it can be observed from the practical examples listed below.

The situation that concerns the energy sector is particularly relevant, since it underwent (and is still undergoing) both the consequences of the Covid-19 pandemic and the still ongoing conflict in Ukraine. While it is true that during the first lockdown there was no crash thus maintaining a stable trend, and that during the second lockdown there was only a slight decrease, we highlight a remarkable growth of the index from February to October 2021, in the health crisis recovery period. However, as proof of the Nowcasting model’s validity we can rely on the analysis of the period from March to June 2022, when an extraordinary increase of the index is registered, caused by the beginning of the conflict between Russia and Ukraine. 

With its analysis, we focused also on the construction industry and we applied the Nowcasting Index to it. As the vast majority of sectors, the construction sector reported an important decrease in the period between January and May 2020, bearing the consequences of the first lockdown. After the latter, the construction industry started a significant growth that brought it almost to reach pre-Covid levels in August 2020. Nevertheless, the positive note that emerges in the filed of the construction sector is the noticeable improvement due to the Superbonus introduction, that is the tax break governed by Article 119 of the Law Decree no. 34/2020 (Relaunch Decree), that consists of a deduction of 110% of the expenses incurred for the implementation of specific measures aimed at energy efficiency and at static consolidation or seismic risk reduction of buildings. From January 2022, the trend underwent some slight drops correspondent to short periods of reduced demand.

If we look at the food service sector, a dramatic drop of the index can be noticed in the period between January and May 2020, caused by strict restrictions and closures from the first lockdown throughout the crisis triggered by the coronavirus. Moreover, the analysis on the performance of the food service industry in Italy, conducted by using Nowcasting data, shows that the sector was able to reach pre-pandemic results in the period May – October 2020, but further experiencing the consequences of the pandemic crisis during the second lockdown, thus meeting its all-time low in March 2021. After that, the food service sector started its virtuous recovery process, reaching the figures from the beginning of 2020.

What can be deducted from our analysis is that the Nowcasting is positioned as one of the most innovative tools with predictive power in the financial world in order to assess the riskiness of a given enterprise in the short term, as well as with the ability to deliver a representation of a given sector’s trend. Both essential formulas to deal with greater preparedness and solidity the world of uncertainty that we live in.