What is a Credit Score?
A credit score is essentially a determination of the capacity of an individual to repay the borrowed sum of money on credit. This statistic primarily mirrors the creditworthiness of a person wanting to access credit in the future. The credit rating agencies, or the Credit Information Companies (CICs), viz. Equifax (ECIS), CRIF High Mark, CIBIL TransUnion—the first CIC in India, and Experian, generally assimilate the required data on various determinants such as the duration of the credit subscription, repayment history, credit inquiry, etc., to determine the credit score statistic of the credit-seeking applicant.
Generally ranging from 300 (lowest) to 900 (highest), a high credit score (above 750—in the case of CIBIL credit score) increases the likeliness of successfully subscribing to a loan or a credit card in the future. Notably, the credit score system followed by Equifax falls within the range of 1 (lowest) to 999 (highest). Essentially, per the directions given by the Reserve Bank of India (RBI), the banks disbursing lending money to borrowers share the necessary transactional information with all the four CICs. Doing so makes it possible for any bank to request access to your credit score details when deciding on approving or rejecting your application to borrow money or subscribe to a loan.
What is Credit Risk?
Credit risk is the potential risk of loss that is an outcome of a borrower’s inability to repay a loan or abide by the contractual stipulations. It essentially relates to the risk that a lender might not realise the principal money that is lent and lose the interest, thereby resulting in a disruption of cash flows. So, meticulous assessment and supervision of credit risk are vital to decrease the magnitude of loss. Identical to the scenario when lenders tender mortgages, loans, or credit cards, there is an associated risk that comes with the potentiality that the borrower could possibly fail to repay the loan.
What is a Credit Risk Assessment?
Credit Risk Assessment is the quantitatively indicative representation of one’s future credit risk determined after giving due consideration also to one’s past credit behaviour. Essentially, meticulous credit risk assessment assists in deciding if the credit risk presented by a borrower falls within the required institutional limits of risk-tolerance. In order to measure credit risk on a consumer loan, lenders give due consideration to the past credit records, repayment ability, capital, terms, conditions of the loan, and the collateral offered. For gauging the credit risk linked to serving its incumbent and future customers, credit risk assessment is initiated by companies.
Are Credit Risk and Credit Score Different?
Yes, there is indeed a slender distinction between credit risk and credit score. Misunderstandings often result in the selection of unfavourable credit or lending alternatives in the retail and institutional markets by the lending companies. First of all, so far, credit risk assessment has been an ‘estimate’ that is built over a period of time considering the health of the credit score (past credit history). Instead, what is necessary following the historic economic and financial meltdowns is an absolute paradigm shift in the pattern of approving or rejecting the credit to people where considerable emphasis is put on future creditworthiness (necessary also to ensure healthy financial inclusion).
Acknowledging a distinction between credit scoring and credit risk is essential as doing so also duly signals the (credit-centric) behavioural (finance) inadequacy, developed of late (if any), of the borrowers. This is because past (positive) credit history of a person is not a testament to the sustenance of repayment regularity in future credit lines. Hence, solely taking into consideration the past credit history and behaviour for deciding on future credit lines of a person doesn’t sound convincing. Especially in the case of the underserved (unskilled and semiskilled) people of developing economies (like India and South East Asia), who have just recently been able to benefit from the gig work opportunities presented by the advent of the gig economy culture, there is no past credit history available at all, since they are mostly still unbanked. Conclusively, in such a scenario, it should hold enough credibility to consider their willingness to access capital and credit whilst presenting a robust credit finance repayment propensity (future creditworthiness).
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