The decision of whether or not lenders approve of a loan application entirely depends on your creditworthiness. After all, lenders will only offer credit to responsible borrowers and gauge the risk of lending to applicants before. However, not many are aware of the difference between credit score and credit risk assessment. While lenders used to rely solely on credit scores to assess the repayment ability of applicants, things have evolved over time.
Today, financial institutions implement a credit risk assessment process to evaluate the creditworthiness of a borrower. But how is the framework of credit risk management different from credit score assessment? What is their impact on personal loan interest rates? Here’s all you need to know.
A credit score summarises your creditworthiness on the basis of your credit history using a three-digit figure. Lenders often use this number to evaluate the probability of timely debt repayment. This numerical representation ranges from 300 – 900 and logically, the higher the score is, the better your financial trustworthiness.
While there are four credit scoring companies authorised to issue credit scores in India, the CIBIL score issued by TransUnion CIBIL is the most popular one among these. The credit scoring system ranges from 300 – 900. A score of 750 or above is considered optimal while a score lesser than 600 may lead to a delay or even a rejection of loan application.
Remember that the credit score plays a crucial role in loan approval or rejection. Furthermore, this is also one of the critical factors affecting your personal loan interest rates. If you have a higher score, lenders perceive you as a trustworthy borrower.
Thus, you need to maintain a healthy score and a sound repayment history to avail of loans on favourable terms and conditions. While some lenders may sanction loans to borrowers with a low credit score, you may end up paying huge interest on your loan. This increases your interest outgo and your overall loan borrowing costs.
What is a credit risk score, though? This simply predicts the probability that a borrower may be unable to meet the required loan repayment schedule for a period of 90 days or more over a span of the next 24 months. While a credit risk score assesses the probability of overdue EMIs, it may also hint at the probability of defaults. This is when a borrower doesn’t repay the loan at all.
The calculation of credit scores is based on numerous factors, as listed below:
Remember that maintaining an optimal credit score does not necessarily guarantee loan approval. Instead, it simply increases your chances and helps you negotiate loan terms quickly with the lender.
Credit risk assessment involves analysing the probability of defaults on loan repayments by a borrower. This is the risk a lender may incur if the borrower does not repay the interest and principal. Thus, it is crucial for any lender to conduct a credit assessment before approving a loan application.
With credit assessment in place, financial institutions can assess a borrower’s repayment capability and gauge the risk factor accompanying it. Here are five factors lenders consider when executing the credit assessment process:
With credit risk analysis replacing a credit score check to analyse a borrower’s repayment capacity, most financial institutions have established individual departments for gauging it.
Remember that credit risk analysis has a critical impact on your loan interest rate. As the credit risk of a borrower becomes higher, the interest rate of the credit will also subsequently increase. In instances when the credit risk rating of a particular individual is very high, lenders may even decline the loan application. Simply put, a better credit risk rating can help you afford loans.
Knowing the differences between credit score and credit risk assessment is crucial before you apply for a loan. While both rely on past credit history, the methodology applied in credit risk assessment is different from the former.
These assessments provide a comprehensive view of a borrower. Most lenders these days are also implementing credit risk management, helping them mitigate and measure the risk associated with any form of credit. By evaluating the credit risk involved well in advance, lenders can tackle unexpected events of defaults more efficiently.
Banks and big financial corporations are likely to use credit scores as an important, perhaps leading factor in their assessments. This is in contrast to new-age lending portals like Fibe. We offer personal loans using a broader approach to credit risk assessment that does not rely on just credit scores. Fibe factors in your ‘Social Worth Score’ based on a range of factors, allowing us to arrive at a more accurate estimation of your borrowing capabilities.
Looking for an instant personal loan? Get started with Fibe, India’s largest Personal Loan platform. Download our instant loan app here and get quick approvals on personal loans at affordable interest rates and convenient repayment tenors.
The three types of credit risk are concentration risk, default risk, and institutional risk. There are two other types of risk, too – downgrade risk and country risk.
Lenders conduct a credit risk assessment by factoring in the 5 Cs – Credit history, capability to repay, conditions of the credit, capital, and collateral offered.
No, a credit score is different from a credit risk assessment. The latter gives a more comprehensive idea about the possibility of a borrower defaulting on repayment.
A credit risk score is evaluated by different credit agencies by factoring in a range of factors related to your credit repayment ability.
A good credit risk score is AAA, AA, A, and BBB. Any score lower than BBB is considered a low credit risk score.
The 5 principles of credit risk management rely on the following criteria:
The most common credit risk parameters include the probability associated with loan defaults, loss related to the default and the exposure a lender faces at the time of default. Analysing such parameters well in advance forms the basis of credit risk management.
CRR measures the probable degree of risk associated with a borrower who has availed or is yet to avail of a loan.
A credit risk limit is the maximum limit constraining an individual or the maximum amount of credit exposure related to the outstanding loan balance.
Credit risk analysis not only predicts the profitability of any borrower defaulting on a loan but also helps in assessing the severity of the loss incurred in the case of default. One typical example is the debt service coverage ratio, which helps measure the cash flow available to help any lender repay its current debt obligations.
