Capital Markets

How banks use credit scoring to determine whether you are risk borrower

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This year, Kenyan banks are moving to a risk-based loan pricing model that differentiates the costs for individual borrowers depending on the risk of default.

The move to the risk-based model is meant to unlock credit for sectors or individuals who were previously deemed too risky to lend to by banks—which will now be able to load a premium on rates to cover themselves when lending to such borrowers.

One of the factors to consider when rolling out a risk-based lending plan is the credit score of a borrower, which basically gauges the reliability of a borrower in servicing their loan facilities.

The government hopes a more refined credit scoring system will unlock credit to the private sector and ensure that no borrower is denied a loan based on their past repayment records.

The Business Daily got Gideon Kipyakwai, the chief executive of credit reference bureau (CRB) service provider Metropol Corporation, to help explain what is taken into account when assigning a credit score to a borrower, and what one needs to do to improve their score.

Payment performance behaviour

This factor carries the highest weight on a credit score, at about 45 percent. The CRB considers the payment history on previous loans, primarily whether the borrower has serviced a facility faithfully and paid their installments on time.

It helps if the borrower has not had disputes with lenders over payment terms, and avoided reminders to service loans. A clean payment record offers comfort to lenders that they will recover their money from the borrower.

Credit mix of existing loan facilities

Banks are often wary of borrowers who have been caught in a roll-over cycle for loans, where they effectively borrow from one bank to repay another’s loans. It also manifests through loading of loans, where a borrower has taken up a varied mix of facilities from different lenders.

This suggests that a borrower is facing distress and cannot raise enough income or revenue independently to sustain existing obligations. As such they are assigned a high-risk rating when they are accessing new credit.

For a CRB, this is a red flag, and as such this consideration is assigned a score weighting of about 30 percent.

Total debt relative to income and the trend

Related to the factor of loading loans, the credit score is also affected by the ratio of debt to income. The higher the percentage of income going towards servicing debt, the higher the risk of default. This is considering the fact that there are other competing needs eyeing the income pot.

The trend of growth of debt relative to income also matters, signalling whether there is growing or narrowing room to take on more debt. This factor, and the others below, all get a weighting of six percent or less in the overall credit score.

Treatment of new loans

The treatment of new loan facilities is of interest to a CRB when computing a credit score, primarily in terms of collateral demands.

If a borrower who was previously able to access collateral-free loans is suddenly being asked to provide a security, a credit scorer will see this as a sign of emerging difficulties in servicing loans, and offer a lower score as a result.

Demographics

The demographic factor (primarily age and gender) is also considered in credit scoring, based on the repayment behaviour of a particular demographic group.

For instance, banks’ loans data might show that a certain age group has been recording higher defaults compared to others, and this then feeds into the general risk perception when a borrower fitting into this demographic seeks credit.

Stability factor

Stability factor considerations are wide and varied, ranging from whether one has been domiciled in the same place for a lengthy period, holding consistent contact details such as mobile numbers, and keeping with one employer for a long time.

Frequent changes of mobile numbers, moving houses and jobs often are signs of instability, which raises concerns for lenders. In particular, in this age of digital loans, changing mobile numbers frequently can be a sign of payments distress, which has caused some people to discard lines in a bid to evade the lenders.

How can you improve your credit score?

The easiest way to build a good credit profile is to avoid, and if any, quickly resolve any loan disputes.

One should also check their records to ensure they are clean, and take steps to make good if there are any concerns raised by lenders.

There is also a misconception that by avoiding loans, one keeps their record clean. Demonstrating the ability to repay a loan is a plus in getting a good score, with lenders generally not willing to afford a high credit score to new borrowers whose repayment behaviour remains an unknown factor.

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