Introduction to consumer credit and credit scoring

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1 University Press Scholarship Online You are looking at 1-10 of 12 items for: keywords : credit scoring Credit scoring Tony Van Gestel and Bart Baesens in Credit Risk Management: Basic Concepts: Financial Risk Components, Rating Analysis, Models, Economic and Regulatory Capital Published in print: 2008 Published Online: January 2009 ISBN: eisbn: acprof:oso/ This chapter provides an introduction to credit scoring. The chapter is organized as follows. Section 2.2 discusses the use of scores during different stages of the customer cycle, while section 2.3 compares scoring functions based on their characteristics concerning risk type, risk entity, and the score source. Credit bureaus are a popular external reference source for scoring and are discussed in section 2.4. The concept of overruling or overrides is reviewed in section 2.5. The different business purposes of credit scoring are reviewed in section 2.6. Section 2.7 concludes the chapter with a critical review of the limitations of scoring systems. Introduction to consumer credit and credit scoring Lyn C. Thomas in Consumer Credit Models: Pricing, Profit and Portfolios Published in print: 2009 Published Online: May 2009 ISBN: eisbn: acprof:oso/ This chapter outlines what is meant by a credit score, why it is an integral part of the decision process in lending to consumers, and how credit scoring systems are built. After describing the historical development of consumer credit and credit scoring, decision trees are used to model the credit granting process. In particular, return on capital based models and their connection with the tradition expected profit model are introduced. The chapter defines what is meant by a credit score, why log odds scores have such useful properties, and how one Page 1 of 6

2 can extend the definition of a credit score to time dependent scores. It then goes through the development process of building a scorecard, discussing sample construction, reject inference, coarse classification, and variable selection. It concludes by looking at the different methodologies for building a scorecard such as logistic regression, linear regression, classification tress, and linear programming. Risk modelling and measurement Tony Van Gestel and Bart Baesens in Credit Risk Management: Basic Concepts: Financial Risk Components, Rating Analysis, Models, Economic and Regulatory Capital Published in print: 2008 Published Online: January 2009 ISBN: eisbn: acprof:oso/ This chapter highlights the conceptual aspects of a rating system without focusing on mathematical and technical aspects. An overview is provided of the different aspects of risk measurement and modelling: data, modelling techniques, and implementation for use. All aspects of the development and implementation of a new model are discussed. The system life cycle is explained in section 4.2. Section 4.3 provides a high-level overview on credit scoring models. Such models rely on data, for risk measurement, model use, and model development. The data issues are discussed in Section 4.4. Section 4.5 provides a bird's eye view on the model development process of internal rating systems. Implementation aspects are discussed in Section 4.6. Section 4.7 explains that models need to be maintained and updated regularly. Section 4.8 explains the different, but also partially overlapping aspects of model validation, quality control, and backtesting. Portfolio credit risk and the Basel Accord Lyn C. Thomas in Consumer Credit Models: Pricing, Profit and Portfolios Published in print: 2009 Published Online: May 2009 ISBN: eisbn: acprof:oso/ The previous chapters in the book have concentrated on modelling decisions and uncertainties on one consumer loan. This chapter concentrates on models related to portfolios of such loans. In particular it looks at the economic capital and regulatory capital needed to cope with Page 2 of 6

3 the credit risk in a portfolio of consumer loans. It concentrates on how the Basel Capital Accord, in place since 2007, impacts on credit scoring and is in turn dependent on credit scoring. The chapter reviews what the Accord requires and how the minimum capital requirement formula can be derived. It then looks at the impact it has on credit scoring with the increased importance in validating the prediction probabilities of the default scores, and the need to calculate long run average probability of default rates from credit scores. Models are developed to show how the Basel regulations will change the optimal cut-off scores in the application process. The various portfolio credit risk models for corporate loans and whether there are equivalent models appropriate for assessing the credit risk for portfolios of consumer loans are discussed. These are useful for stress testing as required in the Basel Accord. Consumer Credit Models: Pricing, Profit and Portfolios Lyn C. Thomas Published in print: 2009 Published Online: May 2009 ISBN: eisbn: Item type: book acprof:oso/ Credit scoring the quantitative and statistical techniques which assess the credit risks when lending to consumers has been one of the most successful if unsung applications of mathematics in business for the last fifty years. Now though, credit scoring is beginning to be used in relation to other decisions rather than the traditional one of assessing the default risk of a potential borrower. Lenders are changing their objectives from minimizing defaults to maximizing profits; using the internet and the telephone as application channels means lenders can price or customize their loans for individual consumers. The introduction of the Basel Capital Accord banking regulations and the credit crunch following the problems with securitizing sub prime mortgage mean one needs to be able to extend the default risk models from individual consumer loans to portfolios of such loans. Addressing these challenges requires new models that use credit scores as inputs. These in turn require extensions of what is meant by a credit score. This book reviews the current methodology for building scorecards, clarifies what a credit score really is, and the way that scoring systems are measured. It then looks at the models that can be used to address a number of these new challenges: how to obtain profitability based scoring systems; pricing new loans in a way that reflects their risk and also customise them to attract consumers; how the Basel Accord impacts on way credit scoring; and how credit scoring can be extended to assess the credit risk of portfolios of loans. Page 3 of 6

4 Analysis of the EU Credit Rating Agencies Regulation Garcia Alcubilla and Ruiz del Pozo in Credit Rating Agencies on the Watch List: Analysis of European Regulation Published in print: 2012 Published Online: May 2012 ISBN: eisbn: Page 4 of 6 acprof:oso/ Due to the financial crisis, a new European System of Financial Supervisors including a new authority, ESMA, in charge of the oversight of rating agencies, was established. The chapter presents an overview of this new financial architecture and provides an in-depth analysis of the European Regulation on rating agencies. It explains the regulatory use of ratings in the EU, analysing the ECAI recognition process of the Capital Requirements Directive, which implements the Basel framework. It also examines the registration process and the supervision and enforcement framework, and ESMA s sanctioning powers. Finally, the chapter analyses in detail the requirements to enhance agencies governance, to manage conflicts of interest, to improve the processes to develop and review methodologies and models, and to increase disclosures on individual ratings and on transparency of agencies activities. The Regulation is examined in light of all relevant guidance from ESMA, IOSCO, and other supervisors, related EU legislation, and SEC s rules. Retail capitalism in the parlour: mail order catalogues Sean O'Connell in Credit and Community: Working-Class Debt in the UK since 1880 Published in print: 2009 Published Online: January 2009 ISBN: eisbn: acprof:oso/ This chapter explains how catalogue retailers successfully expropriated working class social networks. Mail order evolved from an experiment with draw clubs to a billion pound credit base industry. Its mainly female agents were largely socially rather than financially motivated, and they embedded the catalogue in many social networks. However, until the 1930s catalogue retailers were reluctant to appoint female agents due to concerns about the legal status of married women's credit bargains. Credit assessment and policing by agents allowed mail order to keep bad debts at low levels. Agents were typically of a higher social status than customers and acted as a gatekeeper to credit for them. From the 1980s, increasing female employment, greater access to other forms of credit, and declining levels of trust in working-class neighbourhoods

5 created credit orphans of some former customers. Together with computerization and credit scoring, this was a significant factor in financial exclusion. The Supply of Consumer Credit Thomas A. Durkin, Gregory Elliehausen, Michael E. Staten, and Todd J. Zywicki in Consumer Credit and the American Economy Published in print: 2014 Published Online: August 2014 ISBN: eisbn: acprof:oso/ Consumer credit supply arises through a production process called financial intermediation. Intermediation involves transfer of funds from consumer savers to consumer borrowers through institutions that serve as financial intermediaries. Intermediaries make the transfer more efficient than a direct transfer by managing information processing, risk intermediation, monitoring, temporal intermediation, and size intermediation. Although these aspects of production reduce overall costs, they cannot reduce costs to zero, and remaining costs vary among classes of institutions. The chapter reviews the production process and these costs and then discusses how risk costs lead to the possibility of credit rationing. Finally, the chapter begins discussion of how consumer credit granting institutions have attempted to reduce costs through technological means such as statistical credit scoring and obtaining funds to lend through new kinds of financial market instruments collectively known as asset-backed securities (ABSs). Credit Reporting Thomas A. Durkin, Gregory Elliehausen, Michael E. Staten, and Todd J. Zywicki in Consumer Credit and the American Economy Published in print: 2014 Published Online: August 2014 ISBN: eisbn: acprof:oso/ Desire to improve lending information and reduce risk costs has given rise to credit reporting agencies, colloquially known as credit bureaus. Borrowers have an incentive to disguise their relative risk (if it is high) or to signal it (if it is low). This chapter examines first the conceptual rationale for the emergence of information sharing across lenders and then the foundation for a credit reporting industry. Next, the discussion focuses on the particular variety of credit reporting and its domestic Page 5 of 6

6 regulation under the Fair Credit Reporting Act. Availability of information files has led directly to a wide array of innovative, data-based decision tools and credit scoring products now available to assist lenders. The chapter then examines the resulting benefits to consumers, creditors, and the economy. The system is not without flaws, and the chapter also reviews currently available evidence on the accuracy and quality of credit reports. Consumer Credit and the American Economy Thomas A. Durkin, Gregory Elliehausen, Michael E. Staten, and Todd J. Zywicki Published in print: 2014 Published Online: August 2014 ISBN: eisbn: Item type: book acprof:oso/ Chapters 1 to 5 discuss types, trends, and basic economics and psychology of consumer credit use, including credit demand, credit supply, theories from behavioral economics, and financial intermediation. Chapters 3 and 4 focus on how credit use can be productive for individuals (that is, wealth-increasing when there is a positive net present value to the transaction) and how it can change the timing of consumption to a preferred pattern. Individuals intuitively realize this, and survey evidence suggests that most uses of consumer credit involve productive purposes. Some uses of consumer credit may on occasion be less productive, even to the point of involving some sort of underlying irrational decision making, but irrationality is by no means the expectation or the norm. Chapters 5 to 8 then examine in considerable detail the credit production process known as financial intermediation. These chapters review how the development of consumer credit and its institutions reflect ongoing attempts to reduce the cost of the production process leading to technological change, evident in credit scoring, credit bureaus, and credit cards. Chapter 8 looks closely at specialized credit products sometimes known as fringe products. Chapters 9 to 13 examine the nature and effects of federal and state regulation of consumer credit. Chapter 12 includes ancillary products such as debt protection, including credit insurance, and a credit substitute in the form of automobile leasing. Chapter 13 examines what happens when things go seriously wrong, the domain of credit counseling and the consumer bankruptcy system. Chapter 14 provides a conclusion. Page 6 of 6