A profit-based scoring system in consumer credit: making acquisition decisions for credit cards

Abstract

Consumer credit scoring is one of the most successful applications of quantitative analysis in business with nearly every major lender using charge-off models to make decisions. Yet banks do not extend credit to control charge-off, but to secure profit. So, while charge-off models work well in rank-ordering the loan default costs associated with lending and are ubiquitous throughout the industry, the equivalent models on the revenue side are not being used despite the need. This paper outlines a profit-based scoring system for credit cards to be used for acquisition decisions by addressing three issues. First, the paper explains why credit card profit models—as opposed to cost or charge-off models—have been difficult to build and implement. Second, a methodology for modelling revenue on credit cards at application is proposed. Finally, acquisition strategies are explored that use both a spend model and a charge-off model to balance tradeoffs between charge-off, revenue, and volume.

Keywords:

• finance
• banking
• consumer credit
• credit scoring
• risk
• multi-objective

after one revision

The views expressed in this paper are those of the author and do not necessarily represent those of the Federal Reserve Bank of Chicago or the Federal Reserve System.

after one revision

The views expressed in this paper are those of the author and do not necessarily represent those of the Federal Reserve Bank of Chicago or the Federal Reserve System.