Whenever an industry encounters problems, the natural tendency is to play the blame game. In the banking industry, credit risk managers are looking for who or what to blame for the tide of charge offs and delinquencies in their under-performing loan portfolios and in their commercial loan origination operations. Credit scoring has definitely taken it on the chin as an easy target during 2008.
Is credit scoring the problem? Absolutely not!
As with anything, the more complacent we become…and the more we “turn off our brains” and stop thinking…the more risk we assume. The more we solely rely upon the credit score alone, the more we subject ourselves to the risks inherent in “score and go” lending.
We are all well aware that credit scoring measures propensity to repay and not capacity to repay. Over the past several years, the propensity to repay has been boosted by ever-increasing real estate values and by the refinance boom. For example, some consumers have been able to survive on a 50 percent debt–to- income due to constant use of credit cards …by paying off those cards with a home mortgage refinance. That set of behaviors would have shown a propensity to repay…but was it ever acceptable to have 50 percent of your income go to debt payments?!
Statistically it may have worked for a few years, but once real estate values stopped escalating, the problem with lack of capacity to repay reared its ugly head.
When it comes to risk management, let’s get back to reality and sound principles.