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Application of Scenario-based Forecasting to Retail Loan
Portfolio Analysis
Signals, Spring 2004

Scenario-based Forecasting
[Larger image]

The graphic at right illustrates how a scenario-based forecasting process may be leveraged to build, manage, and maintain a profitable portfolio.

Around the outside of the circle are listed nine forecasting efforts that all lending institutions pursue. It is standard practice for these efforts to be handled in different departments, with different forecast methodologies and/or with different data sets. It is often difficult to reconcile any of these forecasting outcomes with any other, or change the assumptions made for one forecast outcome and see the results in another outcome. This situation obviously limits the usefulness of any individual forecast since it's difficult to know the impact on other areas.

The circle graphic, however, illustrates a different approach. Think of the whole circle as a series of concentric wheels that can be dialed around the central axis. At the center of the wheel are core components drawn from analyzing historical results. These core drivers, once refined, do not normally change. By following each arrow out from the center, you may note the required elements for each forecasting effort, with the final processing step noted in the outer circle.The return arrows indicate where an optimization step may be usefully employed to feed forecast results back into scenario design.

Each of the boxes that make up each wheel represent various scenarios that may be shared across forecast efforts. Once you solve for one forecast outcome, the scenario inputs may be shared to obtain useful combinations. For example, by combining the scenario elements of the optimal marketing plan (1 o'clock on the wheel) with those of the economic scenario forecast (5 o'clock), you may obtain the optimal marketing inputs for the portfolio under a forecast for the economy—e.g., "precisely what kinds of accounts (and amounts) should I book in a future economy described by my favorite economic forecaster in order to obtain the desired portfolio performance?"

Keen forecasting is a crucial element for sustained portfolio success. Yet many institutions miss the chance to make better strategic decisions because their portfolio forecasting process is not well integrated. A well-organized scenario-based forecasting process can generate all these outcomes and manipulate them interdependently. The result is better consistency, transparency, and decision quality.
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