The Benefits of Using the Credit Risk Scorecard
Measuring credit risks leads to improvement in credit risk management. One of the tools to assess the performance in handling credit risk is 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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