DID YOU KNOW: How to Correctly Interpret Credit Risk in an Economic Downturn
Examination uncovers how credit scores can be used as continued economic dislocation looms
VantageScore Solutions, LLC, developer of the VantageScore credit score model, released today a whitepaper on the VantageScore credit score’s role in understanding consumer credit risk and the need to closely monitor the risk represented by a given credit score in an increasingly volatile economic environment.
VantageScore’s latest whitepaper “The Dynamic Relationship Between a Credit Score and Risk: How to Correctly Interpret a Credit Score During an Economic Downturn”, provides lenders and other users of credit scores transparent details about how the score-to-default risk relationship changes over time, and notes the importance of timely and active credit risk management in order to make proper portfolio adjustments and credit score cut-off recalibrations in response to shifts in the economy.
Some insights from the study are below:
- Default levels fluctuate over time because they reflect macroeconomic conditions, such as the unemployment rate, interest rates and home values, all of which can either increase or decrease risk levels.
- Data from the 2008-2010 financial crisis provides a useful indication for how risk can shift, where default rates for new originations as well as exiting accounts were 200-250% higher for a given credit score band when compared with a more stable economic timeframe (2017).
- Close monitoring of risk results and building in forward-looking expectations and scenarios around how those results may change, are necessary in setting (or calibrating) the score cut-offs.
- Given the unprecedented impact of the COVID-19 pandemic and the high degree of uncertainty about the shape of the economic recovery and longer-term consumer impacts, the need for closely monitoring and managing risks is even greater.
“Credit scores are often improperly thought of as absolute predictors of whether a borrower will default on a loan,” said Barrett Burns, president and CEO of VantageScore Solutions. “In reality, a credit score is a representation of risk accomplished by rank ordering the scoreable consumer population based on who is least and most likely to default. Inherently, as the overall economy slows, the risk associated with scores will shift in accordance. By understanding this relationship, lenders can make better, safe and sound decisions while protecting consumers from becoming overleveraged.”
For more details from the “The Dynamic Relationship Between a Credit Score and Risk – How to Correctly Interpret a Credit Score During an Economic Downturn,” study, visit: www.VantageScore.com/ScoreRiskWP.