How to see it coming: predicting bank distress with machine learning

Joel Suss and Henry Treitel

The need to see it coming

The great American baseball sage, Yogi Berra, is thought to have once remarked: ‘It’s tough to make predictions, especially about the future’. That is certainly true, but thankfully the accelerating development and deployment of machine learning methodologies in recent years is making prediction easier and easier. That is good news for many sectors and activities, including microprudential regulation. In this post, we show how machine learning can be applied to help regulators. In particular, we outline our recent research that develops an early warning system of bank distress, demonstrating the improved performance of machine learning techniques relative to traditional approaches.

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Opening the machine learning black box

Andreas Joseph

Machine learning models are at the forefront of current advances in artificial intelligence (AI) and automation. However, they are routinely, and rightly, criticised for being black boxes. In this post, I present a novel approach to evaluate machine learning models similar to a linear regression – one of the most transparent and widely used modelling techniques. The framework rests on an analogy between game theory and statistical models. A machine learning model is rewritten as a regression model using its Shapley values, a payoff concept for cooperative games. The model output can then be conveniently communicated, eg using a standard regression table. This strengthens the case for the use of machine learning to inform decisions where accuracy and transparency are crucial.

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Stirred, not shaken: how market interest rates have been reacting to economic data surprises

Jeremy Franklin, Scott Woldum, Oliver Wood and Alex Parsons

How do markets react to the release of economic data? We use a set of machine learning and statistical algorithms to try to find out.  In the period since the EU referendum, we find that UK data outturns have generally been more positive than market expectations immediately prior to their release. At the same time, the responsiveness of market interest rates to those data surprises fell below historic averages.  The sensitivity of market rates has also been below historic averages in the US and Euro area, suggesting international factors may also have played a role. But there are some signs that the sensitivity has increased over the past year in the UK.

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New machines for The Old Lady

Chiranjit Chakraborty and Andreas Joseph

Rapid advances in analytical modelling and information processing capabilities, particularly in machine learning (ML) and artificial intelligence (AI), combined with ever more granular data are currently transforming many aspects of everyday life and work. In this blog post we give a brief overview of basic concepts of ML and potential applications at central banks based on our research. We demonstrate how an artificial neural network (NN) can be used for inflation forecasting which lies at the heart of modern central banking.   We show how its structure can help to understand model reactions. The NN generally outperforms more conventional models. However, it struggles to cope with the unseen post-crises situation which highlights the care needed when considering new modelling approaches.

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