Monetary and relative scorecards to assess profits in consumer revolving credit

Abstract

This paper presents for the first time a relative profit measure for scoring purposes and compares results with those obtained from monetary scores. The suggested measure is the cumulative profit relative to the outstanding debt. It can also be interpreted as the percentage coverage against default. Monetary and relative measures are compared with both being estimated using direct and indirect methods. Direct scores are obtained from borrower attributes, while indirect scores are predicted using the estimated probabilities of default and repurchase. Results show that specific segments of customers are profitable in both monetary and relative terms. The best performing indirect models use the probabilities of default within 12 months on books. This agrees with existing banking practice of default estimation. Direct models outperform indirect models. Relative scores would be preferred under more conservative standpoints towards default because of unstable conditions and if the aim is to penetrate relatively unknown segments. Further ethical considerations justify their use in an inclusive lending context.

Keywords:

• profit scoring
• return scoring
• credit risk
• accounting
• banking
• inclusive lending

Acknowledgements

We are grateful to the data provider that chose to remain anonymous and to the provider’s contact person for her outstanding help and support throughout the project.