The Benefits of Using the Credit Risk Scorecard
Financial institutions have used credit risk scorecards
to measure the performance of credit companies in handling credit
risks. These scorecards can be acquired from credit risk vendors.
These vendors have developed scorecards to be used in the lending
industry. However, in-house credit risk scorecards have increasingly
replaced the credit risk scorecards obtained from outside sources.
The advancement in technology has helped in the development of credit
risk scorecards within the lending company.
The advantages that come with in-house credit risk
scorecards are that they can be developed inexpensively and faster.
Because the scorecard is developed within the entity for its own
use, there is more flexibility in its creation.
Advancement in software applications is among the
factors that lead to the shift to internal scorecard development
in the assessment of credit risks in lending companies. Many individuals
have become knowledgeable in using software and information technology
products. Moreover, software applications have become more readily
available. Companies may no longer have to invest heavily in infrastructures.
Outsourcing has become a norm in many companies as well. Instead
of hiring advanced programmers to do the job, these software applications
have become user-friendly that it would only require short-term
training for the user to know and develop scorecards.
Advances in the form of data storage have lessened
the burden of compiling the necessary data into one area for storage
subject to analysis. Moreover, lending companies have also realized
that it is more advantageous developing the credit risk scorecard
internally because of expertise in the credit field. The knowledge
of companies developing their internal scorecards leads to the development
of better performing credit risk metric.
The credit risk scorecard is seen as a mathematical
model designed to assess the risks that come with extending debt
instruments and derivatives. This is used to quantify the credit
risk and to be able to determine the amount of capital to be held
in reserve so that the lending company can keep its solvent state
and financial stability.
Credit risk refers to the risk of loss from the
default of payment of the debtor. This risk is inherent in lending
companies. Statistical data have been utilized in assessing the
credit risk. The credit score and credit rating can be seen as tools
to measure the credit risk of a certain borrower.
There are two types of metrics to be integrated
into the credit risk scorecard. These are Expected Loss and Economic
Capital. Expected loss is the probable amount of losses per period
a credit company must anticipate. On the other hand, economic capital
is the measure of the resources that a credit company must allocate
to cover the losses.
Determining the quality of the borrower to default
a loan payment is a responsibility of the lending institution. The
ability of the lending company to measure credit risks brings improvement
to the risk management capability of the company.
Credit risk scorecard is a tool used in credit
risk management, which is also a system lending companies employ
to measure the level of credit risks so as to determine the amount
of capital to be held in reserve.
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