CREDIT SCORES

How Credit Scores Affect the Market

How Credit Scores Affect the Market

Introduction

Credit score is a method of rating credit worthiness of a person or entity (credit risk), based on numerical, statistical methods. Credit score is normally used in consumer markets, which involve loans of small amounts. It is also possible to use it in the business of mobile operators, insurance companies, etc. Credit scoring assign points to fill in some questionnaires developed by the evaluators of credit risk underwriters. According to the results of credit scoring, the creditor takes the decision to approve or refuse an application for a loan (Miller 2010).

Credit scoring systems determine the probabilities of returns, derived from separate groups of borrowers of loans, obtained from the analysis of credit history of thousands of people. It is believed that there is a correlation between social factors (number of children, attitudes toward marriage, the availability of higher education) and conscientiousness of borrower.

Discussion

Expert Credit scoring models have played an important role in assessing the creditworthiness of small and medium-sized enterprises. As for the domestic banking system, some of the countries are characterized by lack of credit bureaus (consumer and business loans), which are widespread in the west, the data, which tends to be a key element in scoring models.

Moreover, the banks of such countries do not possess significant databases on the credit history of borrowers (both physical and legal entities), which makes it difficult, if at all possible to use statistical scoring models. Use of expert credit scoring models allows to circumvent this problem.

Prerequisites

The banking systems, after the dissolution of the socialist bloc and the ensuing liberalization of economies, have begun to actively lend to small and medium businesses, as the most rapidly developing segment of the market lending. Managers of credit institutions, to strengthen the position of their banks, in addition to lending to large enterprises, loans which accounted for many thousands and millions of dollars, turned their attention to the dynamic economic growth in SMEs (Langohr 2008).

Management staff of a number of banks was well aware of the practical benefits of credit scoring systems to work with small and medium-sized businesses in the banking sector in developed countries. However, the management also realized that the classic version, based on credit scoring, is an extensive historical database - the credit history of borrowers, which is the source of authority of the credit bureaus.

Banks, of course, had data on loans granted to small businesses, but the procedure for collecting and storing such data was not systematic. As a result, banks did not have a sufficiently large amount of data to statistical approaches based on a predictive model of the decision to grant credit. In addition, the propensity of banks to share credit information is rather low. Therefore, banks are still not sharing information about the creditworthiness of borrowers, so the burden of the collection, storage and processing of information pertaining to credit continues to lie on each of the banks.

In these circumstances, the best option turned out to be ...