Risk Management and Credit Scoring
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1 Study Unit 5 Risk Management and Credit Scoring ANL 309 Business Analytics Applications
2 Introduction Importance of risk management in CRM Credit Risk Management Cycle (CRMC) Credit scoring Simple credit scorecard Different types of credit scoring
3 Credit and Risk Different forms of credit: credit card, personal lloans, hire purchases, overdrafts and mortgages. Any customer taking credit must repay according to the agreed terms, and pay a risk premium for the possibility that they might not repay. Managing risk is critical to maintaining profitability in many companies.
4 Different Types of Risk Companies in different industries face different types of risks: Insurance: fraudulent claims Credit Card: fraud and stolen credit card Banking: Default of loans
5 Risk and Scoring Scoring The process of numerically rank ordering cases (such as borrowers), according to some real or perceived quality (such as credit risk) in order to discriminate between them. Aids decision making by lending institutions on whether to offer credit to their customers.
6 Credit Risk Management Cycle (CRMC) To manage the risks of offering credits, businesses are engaged in a credit risk management cycle (CRMC): Marketing Solicitation Collection and Recoveries New Business Processing Account Management
7 Marketing Solicitation To manage the risks of offering credits, businesses engage in a Credit Risk Management Cycle (CRMC): Marketing Solicitation New Business Processing Account Management Collection and Recoveries The most expensive task in doing business is to acquire new customers. However, iti is important tto assess the risks of targeting prospective customers before making credit offers.
8 New Business Processing To manage the risks of offering credits, businesses engage in a Credit Risk Management Cycle (CRMC): Marketing Solicitation New Business Processing Account Management Collection and Recoveries Any prospective customer is put through a selection process and will be scored to determine the credit risks of the customer applying for credit.
9 Account Management To manage the risks of offering credits, businesses engage in a Credit Risk Management Cycle (CRMC): Marketing Solicitation New Business Processing Account Management Collection and Recoveries Once the customer is established, it is important to refresh the scores at regular intervals to determine the performance of the account. Doing so will aid in business decisions, such as limiting credit and managing g overdrafts.
10 Collection and Recoveries To manage the risks of offering credits, businesses engage in a Credit Risk Management Cycle (CRMC): Marketing Solicitation New Business Processing Account Management Collection and Recoveries This is possibly the most urgent part of the cycle. It is necessary to determine the likelihood that a customer will default on the loan, and that a defaulted loan can be recovered based on past records.
11 Basel II Accord The Basel II Accord A set of regulatory requirements which helps to clarify the measurement of credit and operational risks. Among other regulatory requirements, Basel II Accord proposes the use of Advanced Measurement Approach (AMA) to measure regulatory capital against operational risk.
12 Basel II Accord In addition, the Basel II Accord standardises the definition of default as follows: 90 days past due, or in excess of the agreed limit; if it is known that there is high probability of loss; and the debt was written-off or sold at a material loss.
13 Credit Scoring Credit Scoring Application of statistical models to transform relevant data into a summary score. That aids the decision of lenders to grant new or prospective customers credit. With credit scoring, companies can decide who will get credit and how much credit these new customers should get.
14 Credit Scoring and Credit Worthiness Credit scoring is often confused with credit worthiness. Credit Worthiness: The borrower s willingness and ability to repay. Credit Scores: A measure of credit risk, which not only considers credit worthiness but also the types of activity that the borrower will engage in with the money borrowed.
15 Date Sources for Scoring Credit scoring depends heavily on data which are obtained from a number of different sources, including: Customer -- application forms, financial statements, asset details, etc. Internal Database -- past transactions, other account performance, etc. Credit Bureau Data -credit bureau (private and public), other lenders, court records, etc.
16 Example: A Credit Scorecard Based on this scorecard, a 26-year-old person, who currently lives in a rented flat and wishes to borrow money for share purchase, will score ( ) = 54
17 Rule to Lend and Threshold Score A credit scoring system will require the establishment of a decision rule to lend and a threshold score level. First, a threshold score level is decided. Data from a credit application will be scored. Decision Rule: If the score is greater than or equal to this threshold, the application is approved; otherwise the application will be rejected.
18 Types of Credit Scorecards The most common types of credit scorecards are: Application Scorecard Behavioural Scorecard Collections and Recovery Scorecard Early Stage Collections Scorecard Late Stage Collections and Recovery Scorecard
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