Assessing the Quality of Retail Customers: Credit Risk Scoring Models
The IUP Journal of Financial Risk Management, Vol. 7, Nos. 1 & 2, pp. 35-43, March & June 2010
Posted: 25 May 2010
Date Written: May 24, 2010
Credit scoring models play a fundamental role in the risk management practice of most banks. They are used to quantify credit risk at counterparty or transaction level in the different phases of the credit cycle (e.g., application, behavioral and collection models). The credit score empowers users to make quick decisions or even to automate decisions and this is extremely desirable when banks are dealing with large volumes of clients and relatively small margin of profits at individual transaction level (i.e., consumer lending, but also increasingly small business lending). This paper analyzes the history and new developments related to credit scoring models. It is found that with the New Basel Capital Accord, credit scoring models have been remotivated and given unprecedented significance. Banks, in particular, and most financial institutions, worldwide, have either recently developed or modified their existing internal credit risk models to conform with the new rules and best practices recently updated in the market. Moreover, the key steps of the credit scoring model’s lifecycle (i.e., assessment, implementation and validation) highlighting the main requirement imposed by Basel II have also been analyzed. It is concluded that banks that are willing to implement the most advanced approach to calculate their capital requirements under Basel II will need to increase their attention and consideration of credit scoring models in the near future.
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