Credit Risk Practices for Retail Banking I Flashcards
What is risk?
The possibility of incurring a misfortune or a loss
What are the 3 principal steps to managing risk?
- Understand what events could happen
- Assess the liklihood of that event actually happening
- Understand the impacts if the event did happen and what could be done to prevent loss either by avoiding the risk or by a contingency plan in place to minimise any loss
What are the lines of defence in a typical risk management model for a bank?
- Front line bankers, treasury department etc. - made up of the banks own personel
- Policies and procedures, internal audit, credit approval, distress lending units, group legal, operational risk, executive committees etc. - again mainly staffed by the banks own personel
- The board of directors, the external auditor, the FCA, govn legislation etc. - this time with external personel who will have contact with the banks staff
What is the primary function of risk management?
- Identify the issue(s) - understand what could happen
- Identify the liklihood - probability
- Put plans in place to solve or mitigate - plan
- Make sure the outcome is dealt with quickly - action/monitor
What risk areas will the banks set number of committees typically address?
- Credit risk
- Asset and liability risk
- Market risk
- Insurance and investment risk
- Operational risk
- Legal and regulatory risk
- Strategy risk
- Audit
What are the main activities that a Credit Risk Committee undertake?
- Recommending the risk appetite and the direction (e.g. for certain industries)
- Regulatory adherence
- Maintaining and approving credit policies
- Portfolio management and credit quality
- Agreeing and monitoring risk and pricing models
- Lending authority control
What is Credit Scoring?
Is the term used to describe systems in banks and financial instutions which allow lenders to automate their credit decision making while also managing the credit risk of those decisions. Credit scoring consists of a statistically derived model (the credit scorecard) which is used to predict a specific outcome and a set of strategies which drive the decision making process. The scorecard refers to the set of points used in scoring an application. Points are allocated according to the characteristics of those applicants whose accounts:
- were fully repaid in time with no issues
- are then compared with the characteristics of those facilities that were either slow to repay and
- are compared again, this time with those who did not repay their loan in full
It is governed by ‘The Guide to Credit Scoring’ with the support of the govn’s Office of Fair Trading.
What is Application Scoring?
In the credit risk arena, a number of diff models can be used to predict diff outcomes. For example, an application scoring model may be built to:
- predict the liklihood of a new loan account going bad or becoming deliquent
- determine credit limit to be allocated to a new credit card
- Predict the credit risk of approving a new current account and providing overdraft facilities
Application scoring is used for new and existing customers and is a single point in time assessment for credit.
What is Behavioural Scoring?
Behavioural scoring can be used to:
- Increase a credit card limit for an existing credit card customer
- Upgrade credit or debit cards from standard to gold and beyond
- Decide whether to pay or return transactions presented against an existing current account if insufficent funds are available
Behavioral scoring unlike application scoring is used for existing customers only and is an ongoing, updateable assessment for credit. Typically it uses application data, credit reference bureau data and behavioural data.
What are the benefits of Credit Scoring?
- A consistent and impartial assessment of customers - all customers are treated the same and fairly
- A uniform method of processing standard customer requests
- Allows management to control the credit tap, that is, increase or reduce credit exposures, thus giving the bank control over approved volumes/bad rates
- An increase in ability to consider volume credit approvals irrespective of value
- A much improved management information system - it is electronically based
- An efficient, cost effective method of a credit risk assessment
- With a standard and tested system, the quality of the credit portfolio will be reliable during a stable economic cycle
What are the boundaries of Credit Scoring solutions?
- A sizeable number of historical applicants and repayment patterns data are normally required to build a credit scorecard
- Can be expensive to build and put in place, although there is a choice between in house built systems and off the shelf purchase systems
- Is time sensitive - efficiency deteriorates over time. Very old data can prove to be unreliable for m aking plans for tomorrow, so scoring systems need to be replaced or updated over time
- Is not infalllible and errors can occur
- Not all lending decisions are suitable for a scoring solution
- Will not solve all credit issues
What must one consider when monitoring credit scoring?
That they are still appropriate to the customer base of the financial org.
What performance areas will the credit scoring review normally measure?
- Stability of the current score in comparison with the historical performance - has the level of declined applications increased for example?
- Have there been changes to the makeup of the customer base?
- How effective has the override performance been (where the lender has not followed the course of action recomended by the scoring system) - has there been stability in override decisions?
- Has the predicatability of the level of defaults or approvals matched actual results?
What orgs use credit scoring or are affected by it?
- Association for Payment Clearing Services (APACS)
- British Bankers Association (BBA)
- Building Societies Association
- Consumer Credit Trade Association
- Council for Mortgage Lenders
- Credit Card Research Group
- Finance and Leasing Association
- Mail Order Traders Association
What are the areas that information held by Credit Reference Agencies (CRA) fall into?
- Public Information
- Shared Credit Account Info - the main UK financial service players have agreed to share electronic details of their customers’ credit agreements. This allows them to check that the details given to them are consistent and that the customer isn’t in default
