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How is a weighted credit score calculated to make an overall credit risk rating?
Wiki User
∙ 12y ago
Focusing on individuals (including guarantors and/or co-signers), most major banks use what is known as a "weighted credit score" to calculate the borrowers credit risk. Part of that score will be derived directly from contents of the credit report and part of that score will be derived from other information about the borrower (e.g., bank relationship/account history, criminal record, income, assets, etc.).
These calculations, better known as "risk models," tend to be proprietary and focused on supporting the larger portfolio strategy of the bank.
To create that model, a bank will look back at all of their recent customer history (usually the most recent 3 to 5 years; depends on the focus of the model) and identify the elements that were predictive of customer default (e.g., number of late payments in the last 12 months) through the use of multiple regression techniques.
The bank will then refine and optimize the model through historical testing. At that point, each element that is related to defaulting will have a coefficient associated with the measure. This coefficient combined with the range of values that the element takes on provides the weighting for the overall score.
For example, say I have a very simple model for predicting default as follows (the higher the score, the higher the risk to lend to the borrower):
Credit Risk Rating = 50 * late payments in 12 months + 200 * legal judgments - 10 * annual income in thousands
In the above model, assuming that the range of late payments and legal judgments are similar (say, historically from 0 to 3), a legal judgment will negatively impact the score 4x as much as a late payment. However, high income will counter the risk.
Wiki User
∙ 12y ago
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