What does Credit Scoring Mean?
Every grown-up has a credit score associated with his identity. It is not necessarily the case that credit scores matter while taking a loan.
The concept of credit scoring emerged from the need of banks and financial institutions to evaluate how customers would repay them. To make this process smoother and more efficient, these lenders gave this task to companies.
These firms have databases of credit records of customers. They use this data to carry out customer assessments using patented calculation techniques. In this way, they can provide intel about a customer’s reliability concerning loan payments.
Initially, credit scoring helped measure a person’s loan-payment ability. However, today the idea finds use in all sorts of financial processes.
Is there an issue with credit scoring?
As of right now, three major firms are into credit scoring, namely: Equifax, Experian, and TransUnion. These three companies between them hold over 90% market share in America and Britain.
These firms use the FICO (Fair Isaac Corporation) model to arrive at credit scores. This model gives weightage to certain factors like the customer’s previous loan payments, types of loans taken previously, and when they were taken.
So, unfortunately, this model only considers past data to evaluate future performances. This is counter-productive to those who live without credit and have good jobs and decent savings.
Someone who has spent all his money on loan payments gets a higher credit score than a person who does not use credit. This has resulted in many financially well-off customers taking loans, just to improve their credit scores.
Can things be better?
It is quite difficult for financially secure people to get a loan. Furthermore, these people are being pushed into debt.
The situation is bad, but not hopeless. The credit score model should include practical parameters that indicate the trustworthiness of loan takers e.g. their spending habits, social media activities, passive income sources, etc.
Research has shown that incorporating the above-mentioned factors could improve the credit scoring mechanism by at least 50%. With the applications of AI, big data & quantum computation, better scoring algorithms can come up very soon.
The issue of privacy
The main roadblock in developing such a data-oriented system is the ethical challenges of acquiring personal data. However, blockchain technology can solve this issue in the future – as it involves encrypted, decentralized storage of data.
What would the future hold?
With more funding, research, development & deployment of privacy-preserving tools – in the future we could exchange data anonymously with financial service providers. This could help us get better quotes, mortgage rates, EMI offers, etc.
The article has been published by the editorial board of the Fintek Diary. Happy Reading. For more information please visit www.fintekdiary.com
