Direct benefits of credit scoring

Credit scoring plays a crucial role in creating these credit opportunities, driving credit penetration and eventually percolation of benefits for the consumers.

Credit plays an important role in shaping the economic and social dynamics of the society. Remember the shrewd moneylender from old Hindi films, who charged enormous and never ending interest on capital, leading to deteriorating financial status for the borrower. Today, thanks to institutionalised credit, we have structured and regulated credit opportunities available for building assets, educating our children and aspiring for economic as well as social growth.

Credit scoring plays a crucial role in creating these credit opportunities, driving credit penetration and eventually percolation of benefits for the consumers.

The basic principle of institutional lending is trust. A lending institution provides credit to a borrower on a mutual understanding that the borrower will repay the sum, along with reasonable interest, through periodic instalments, over a decided period of time. The lender may not know the borrower personally, but will decide to grant credit on the basis of the borrower’s existing income and past repayment record provided by the credit bureau. The interest collected on these repayments serves as the capital for fresh lending to yet another deserving borrower who needs this money for his own growth aspirations. On the other hand, if the borrower defaults on the repayment of the loan, the credit grantor will face losses and will not be able to sustain capital for fresh lending for many more aspiring and deserving consumers.

This is where credit scoring steps in. Credit scores provide the credit grantor the ability to predict the “likelihood of repayment” by the borrower. Simply put, credit scores help the credit grantors to minimise risk of losses due to defaults and ensure profitability for fresh lending. Credit scores enable the lender to infer the risk profile of the borrower so that some “bad borrowers” (high credit risk) are not mistaken as “good borrowers” (low credit risk) and provided credit. This will result in a loss for the lending institution and in turn loss of the much needed credit opportunity for another creditworthy consumer. In simple terms, credit scoring enables lending institutions to create sustainable credit opportunities for deserving borrowers to allow them to build assets for financial growth.
           

But does credit scoring directly benefit consumers? It does.

Here’s how:

Speedier access to credit: When a consumer applies for credit, lenders use the credit score to make faster, more consistent decisions, thereby eliminating much of the risk of human error and subjectivity. Most leading lending institutions in India are already using the CIBIL TransUnion Score for making credit related decisions. Even significant lending decisions can now be made in a matter of hours or minutes rather than days or weeks with credit scoring. This enables faster processing of loan applications and thereby speedier access to credit for consumers.

Availability of affordable credit at better terms: In addition to both speed and convenience, credit scoring may also make credit cheaper, which means lower costs to consumers. Without objective credit scores, lenders may set prices in a subjective manner, resulting in credit products that are expensive for low-risk consumers and inexpensive for high-risk consumers. By reducing the costs of extending credit, credit scoring may enable lenders to give credit to more customers and at overall lower costs.

Credit scoring expands access to credit and drives sustainable credit penetration. It improves loan performance by reducing delinquency rates and containing NPAs. Credit penetration is achieved by significantly identifying ‘good borrowers’ (low credit risk) that otherwise would have been misidentified as ‘bad borrowers’ (high credit risks) and, therefore, would have been denied credit. At the same time, bad risks now have credit denied to them or are no longer subsidised by lower-risk individuals. In the aggregate, lending is increased, leading to greater economic growth, rising productivity and in turn greater financial inclusion.

Visit: www.cibilconsultants.com
Source: Secondary