7/6/24, 8:18 AM Embracing generative AI in credit risk | McKinsey

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Risk & Resilience

Embracing generative AI in credit risk

July 1, 2024 | Article

Credit risk organizations are already adopting gen AI

technologies. How can they deploy them safely and at scale?

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S
ome technologies are so compelling that they quickly take on a life of their
own. Generative AI (gen AI) made the leap from the laboratory to the
mainstream in late 2022, when Open AI launched a public beta of its ChatGPT
service. Within two months, it had more than 100 million users,[ 1 ] making it the
fastest-growing product in human history.

By the first quarter of 2023, big technology companies were integrating gen AI
capabilities into their own products and offering programmatic access to
generative models for business customers. A year on, gen AI is making its mark in
multiple industries, including those that have traditionally taken a relatively
conservative approach to the adoption of emerging technologies—credit risk, for
example.

McKinsey recently surveyed senior credit risk executives from 24 financial

institutions, including nine of the top ten US banks. We asked these executives
about their organizations’ adoption of gen AI, its current use cases, their future
plans for it, and the challenges they expected.

Twenty percent of the respondents have already implemented at least one gen AI
use case in their organizations, and a further 60 percent expect to do so within a
year (Exhibit 1). Even the most cautious of these executives believe that gen AI will
be part of their companies’ credit risk processes within two years.

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Exhibit 1

Use cases in credit risk

As these financial institutions gear up to use gen AI, they are considering potential
applications across the full credit life cycle. In general, such applications use large
language models (LLMs) to combine, summarize, and analyze unstructured data
and natural language. They can also output complex forms of natural language
(such as reports, emails, and summary documents) and generate structured data
or instructions for other software tools. Our survey revealed several potential use
cases for gen AI in credit risk.

In client engagement, gen AI might be used to offer customers hyperpersonalized

product mixes based on their profiles and activity histories. Gen AI systems could
support relationship managers by drafting individualized outreach
communications, summarizing meetings, and suggesting next steps. Gen AI–
powered virtual experts could help customers identify and determine suitable
products.

During credit decision and underwriting processes, gen AI tools could review
documents and flag policy violations or missing data. They could draft outreach
communications seeking clarifications or missing information from customers.
And they could help compile information about customers, conduct credit
analyses, and draft several sections of credit memos before credit officers review
them. Agent-based gen AI systems can autonomously follow task sequences to
extract information from sources, calculate relevant ratios, compare outcomes

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with typical thresholds, and summarize results in credit memos. These capabilities
can all be developed in natural language, using plain English, with limited need for
programming and advanced modeling skills.

Once credit is approved, gen AI can streamline and accelerate contracting

processes. Gen AI systems can draft legal contracts, for example, or create
outreach communications to inform customers about credit decisions and next
steps that may be required.

In portfolio monitoring, gen AI tools can support portfolio managers in multiple

ways, such as automating the creation of routine performance and risk reports or
drafting summaries (based on portfolio managers’ analyses) of portfolio
optimization options. Gen AI systems could even produce subsegment-specific
optimization strategies in line with an organization’s risk appetite and optimize an
existing early-warning system (EWS) by consuming real-time unstructured
information (such as news or market reports) to identify borrowers with elevated
risk or borrower segments that may require attention.

Finally, gen AI tools can support customer assistance processes—for example, by

drafting personalized outreach communications to customers in the event of
issues. Gen AI systems could also identify suitable restructuring options and then
guide customers through the restructuring process. In addition, some institutions
are using gen AI to coach the interactions of their agents with customers, both in
real time and with post-call analyses.

Respondents to our survey say they are exploring gen AI applications in all these
areas. Portfolio monitoring is currently the leading area of activity among the
respondents: nearly 60 percent are pursuing these use cases. Credit application
processes are the next-largest area of reported activity, along with controls and
reporting: just over 40 percent of our respondents report ongoing or planned
projects in both areas (Exhibit 2). Across business lines, respondents see slightly
more potential for gen AI in wholesale than in retail credit.

Exhibit 2

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The current state of gen AI in credit risk

Gen AI has arrived in the credit risk world but has yet to transform it. Executives
surveyed were candid about the current state of their gen AI use cases, which are
mostly narrow, noncustomer-facing solutions addressing specific operational pain
points.

One bank, for example, has developed a proof-of-concept gen AI tool that can
prepopulate climate risk questionnaires for commercial clients. The bank’s
relationship managers are required to periodically complete such questionnaires
as part of their climate risk monitoring. The gen AI system, based on an LLM,
extracts relevant information from the client’s annual reports and other
disclosures. These source documents are preprocessed to identify relevant
sections, which are presented to the model along with carefully designed prompts
asking it to find and summarize key information. The model provides a synthesized
response, including relevant citations to the source material. Finally, human
subject matter experts review and validate the results.

Another use case, which several banks have explored, is the use of gen AI in
drafting credit memos. In commercial banking, the first line must often invest
significant amounts of time in collecting information, performing analyses, and
writing memos for credit decision and underwriting purposes. Gen AI tools can
perform tasks such as extracting, collecting, and sourcing information; analyzing
financial information; visualizing data; and drafting sections of memos by following
preset instructions. Portfolio managers can then review the drafted memo,
together with an estimated confidence level offered by the gen AI tool, before

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finalizing it. In addition to freeing up capacity for other activities, this tool can
improve the consistency and accuracy of the memos generated and, potentially,
speed up the credit decision process.

The programming of such systems can be executed in natural language by using

agent-based systems, without a need for programming or advanced modeling
skills. Meta-agents can coordinate carefully crafted agents, specializing in
specific tasks, to achieve results from multistep tasks. In the case of credit
memos, these can include extracting information, calculating ratios, and
summarizing information. An additional agent layer can boost risk control
mechanisms and help reduce common gen AI pitfalls, such as hallucination.

Since the introduction of such gen AI systems, the banks using them have
reduced the time required to answer climate risk questions by approximately 90
percent, from more than two hours to less than 15 minutes. The system’s answers
are fully correct 90 percent of the time.

Challenges

Executives acknowledge that scaling up the application of gen AI in credit risk will
be challenging. The most significant barriers, highlighted by 75 percent of our
respondents, concern risk and governance. Major risk categories associated with
the use of gen AI include the following:

impaired fairness in algorithms that confuse or mislead users

IP infringements, such as copyright violations or plagiarism

privacy violations resulting from the use of personal or sensitive information to

train models

the generation of malicious content

security threads and related vulnerabilities

performance and explainability issues

the risk of using proprietary data from third parties

environmental, social, and governance (ESG) effects, such as increased carbon

emissions or workforce disruptions

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The key risks can lead to regulatory, legal, reputational, and business
consequences when not effectively managed.

Sixty-seven percent of the participants highlighted potential shortages of gen AI

capabilities inside the organization. Further challenges, cited by around 50
percent of participants, include difficulties defining uses cases and value at stake.

We asked participants to elaborate on the need for frameworks or guardrails to

manage risks in gen AI applications. The top concern, cited by 79 percent of
respondents, was data quality, followed by model risk issues (mentioned by 58
percent), such as transparency, audibility, fairness, and explainability.

A lack of formal and coordinated organizational support for gen AI in credit risk
organizations exacerbates some of these challenges. Only a third of the
respondents’ institutions have established a center of excellence (CoE) to manage
gen AI use cases. Less than 10 percent of the respondents report that their
organizations now define gen AI use cases centrally. Most of them are initiated in
a decentralized manner, so common practices and lessons are not leveraged.

Building a gen AI ecosystem

To capture the full potential of gen AI in credit risk, financial institutions must
move beyond today’s ad hoc approach and develop a common set of practices to
prioritize, develop, deploy, maintain, and reuse gen AI applications. Eight such
practices are essential:

An AI road map. This should align with the organization’s broader business
strategy, explain the required capabilities and solutions, and provide a timeline
for development, launch, and deployment at scale.

Aligned processes for building gen AI tools. These should support rapid—but
safe—end-to-end experimentation, comprehensive validation, and the
deployment of solutions.

A secure, gen AI-ready technology stack that supports hybrid-cloud

environments, so companies can access the computing power they need to
train models and then run them at scale. Such a stack should be able to manage
unstructured data, train and execute models, and pre- and postprocess data.

Integration with enterprise-grade foundation models and tools. These are large
deep-learning neural networks, such as large language models that underpin

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advanced gen AI systems, along with software toolkits that support their
customization and deployment. Gen AI applications use such models directly or
build on them to develop proprietary solutions.

Robust automated supporting tools. These include machine-learning ops

(MLOps, systems to manage training and the development of models) and
appropriate data infrastructure and processing pipelines to support the
development, release, and maintenance of use cases.

A governance and talent model that can deploy cross-functional expertise to

support gen AI development. The people providing this expertise might include
software developers, natural-language-processing (NLP) specialists, teams to
run reinforcement learning based on human feedback (RLHF), cloud computing
specialists, AI product leaders, and legal and regulatory experts.

A modular solution architecture. This allows parallel development and

customizable connections across different layers, such as the UX layer and the
business logic layer.

The product of these practices should be a library of production-ready, reusable

gen AI services and solutions. The items in the library can be plugged into a
range of business scenarios and applications across the credit value chain.

Developing and deploying these eight practices will take most institutions time,
but even deploying some of them can improve efficiency and effectiveness
significantly. For example, institutions that have implemented two practices report
that successful gen AI deployments have been accelerated by 30 to 50 percent.
First, such institutions follow a modular solution architecture that includes three
layers: a user experience layer, a business logic layer, and an infrastructure layer.
These are enabled by the organization’s operating model. Second, the institutions
reuse existing components and adopt open-source libraries; for example,
developers can pick and choose from a multitude of ready-made modules (such
as data retrieval pipelines, prompt libraries, and guardrails) from open-source
tools to build an end-to-end gen AI solution rapidly—often in just one or two
weeks.

Major credit risk players are embracing generative AI at speed. The technology
has transformative potential, promising to improve efficiency, accuracy, and
personalized services across the credit life cycle. Although early adopters have

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begun to reap these benefits, widespread implementation requires financial

institutions to overcome significant challenges related to risk governance, talent
acquisition, and the creation of a comprehensive ecosystem to support gen AI
applications. By addressing these hurdles and fostering an environment that
encourages innovation and collaboration, financial institutions can unlock the full
potential of gen AI, setting a new standard for excellence in credit risk
management.

1. Krystal Hu, “ChatGPT sets record for fastest-growing user base—analyst note,” Reuters, February 2,
2023.

ABOUT THE AUTHOR(S)

Andreas Kremer is a partner in McKinsey’s Berlin office; Arvind Govindarajan is a

partner in the Boston office; Himanshu Singh is a partner in the New York office,
where Ida Kristensen is a senior partner; and Elaine Li is a consultant in the Silicon
Valley office.

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