For more than a year, the Reserve Bank has been egging lenders on to pass on the benefit of cuts in the repo rate (at which RBI lends to the banks) to borrowers. While that still remains a work in progress, retail mortgage borrowers with a decent credit record may get loans at lower rates for a different reason. Public sector lender Bank of Baroda recently said it had switched to a credit score-based approach for determining interest rates rather than charging a uniform rate across the board. “We have internally switched to scoring-based pricing based on the CIBIL score,” P.S. Jayakumar, managing director of Bank of Baroda, recently told a newspaper. “With this, we can identify the right kind of borrower, our due diligence becomes easier, and the probability of a default will be minimal.”
The Credit Information Bureau (India) Ltd, or CIBIL, is an agency which provides credit reports and scores of borrowers. A credit score, or CIBIL TransUnion Score, is a three-digit summary of a person's credit history.
A switch to credit score-based lending is beneficial to both lenders and borrowers. “From the point of view of the lender, it is more predictable and it is lower-cost in terms of touch points to the customer. It lends itself to analysis and it is a lot more objective. It should also lead to better portfolio performance because you can analyse the benefit of each variable score and back-test,” said Anil Kothuri, president, Edelweiss Retail Finance.
The credit score-based approach will bring transparency to the overall underwriting process. “It will educate home loan borrowers on the need to have a good credit score. Through this model, borrowers can apply for home loans online and check their eligibility, interest rate and monthly loan repayment instalment so that they can plan their cash flow. This will allow them to take a faster decision. So the overall time taken for the cycle, which typically includes shortlisting a property to applying for the loan and then final disbursal of the loan amount, will be reduced,” said Rakesh Makkar, managing director, Fullerton India Home Finance Company.
While this approach has long existed in developed economies, because of high proportion of corporate lending in India manual underwriting has been the default approach. And, a few other factors peculiar to India might ensure that the traditional approach will last for some time now. “The credit bureau in India is in its relative infancy. What we have now is a credit score depending on the customer's existing borrowings and his performance on them. In contrast, in the more developed markets of the world, in addition to existing loans, you also have utility payment data and such performance which is agglomerated. So the data points that we have in India are currently quite thin and also the number of people who are there on the credit bureau is quite small. Given the low levels of reporting of income and the fact that many people remain outside the formal system, both (approaches to pricing) will continue to coexist for a bit. But the proportion of people where we will get to score and have objective decision-making will increase,” said Kothuri.
Does that mean other lenders will make the switch soon? It is a strong possibility in the long run. Some lenders have already taken to scoring-based lending in some verticals. “For high-velocity, high-volume products like consumer durables, credit cards and personal loans, many banks are moving into credit scoring. Auto loans are starting to get there,” said Mohan Jayaraman, managing director, Experian Credit Information Company of India. “But then 50 per cent of the portfolio of banks in India is still around mortgages and that is an area where it is not just credit. There is the property documents and so on. So they end up looking at other things to give the loan. As a result, manual underwriting is prevalent in that area.”
Makkar said Fullerton would gradually shift to the score-based model. India's largest lender State Bank of India said in response to a question from THE WEEK that the bank might introduce differential pricing strategy based on grading of home loan borrowers under in-house risk scoring model, which also takes into account credit score.
For all its advantages, though, the credit score-based approach is not perfect and may require adjustments occasionally. “There may be some challenges for self-employed individuals. They do not have a regular monthly income and generally the businesses have a cyclical behaviour. So in certain months of the year, the income will be more and in other months less. In such a scenario, their average bank balance needs to be taken into account to assess their repayment capabilities. We believe that over a period of time, the industry will mature and we can overcome this challenge,” said Makkar.
Isn't there the danger of a good borrower losing out because of a minor technical blot in the record? Jayaraman said this might not be an issue as the process of credit scoring is not purely electronic. “When you go through a credit scoring exercise, a scorecard will have a certain set of cases which will be clear 'accept's and a certain set of cases of clear 'reject's,” he said. “Most banks only put extreme cases where there is multiple delinquency, a bad track record or other negatives into automatic rejection. And there is the third band, called the 'refer' band, where cases are given a manual scrutiny. For small delinquencies, say, a very old credit card, the bank will be able to take that exception and ensure that it is not the reason why a credit rejection happens.”
What is CIBIL credit score?
A credit score is a three-digit summary of a person's credit history given by the Credit Information Bureau (India) Ltd.
Why is it important for a borrower?
A good credit score, more often than not, increases the chances of getting a loan. Some banks even offer lower interest rates for people with a good credit score.
Why is a switch to credit score-based lending beneficial to borrowers?
It makes borrowing easier and more transparent. One can apply for loans online and check eligibility, interest rate and monthly loan repayment instalment.
Why is a switch to credit score-based lending beneficial to lenders?
It is more predictable and is lower-cost in terms of touch points to the customer. It makes portfolio performance easier.
What are the challenges in credit score-based lending?
Currently in India, the credit score depends entirely on the customer's existing borrowings and his performance on them, while in the developed markets, it includes all kinds of bill payments. Also, only a small number of Indians have credit history.
Interview with Shailendra Singh, deputy general manager, marketing, Bank of Baroda
1. What are the benefits you expect from the change in the methodology for determining rates?
Answer: Bureau scores are considered to be a testimony of loan aspirants’ financial discipline to banks and financial institutions for taking a credit decision. A healthy bureau report and a high bureau score indicate that the applicant is managing his/her loans and credit relationships well, and is financially sound. It is also observed at an industry level—portfolio with high credit score has very low chances of delinquencies.
As such, pricing linked with bureau scores of applicants will improve the quality of loans and reduce the delinquencies in the portfolio. Further applicants having good bureau score will get better pricing for their loans.
2. By when do you plan to operationalise the new regime?
Answer: Bank has implemented risk-based pricing linked to bureau score of the applicant for home loans, car loans from April 1, 2016 and for mortgage loans from May 23, 2016.
3. Are any regulatory approvals required for the change?
Answer: No regulatory approval is required in this regard.
4. Are there any global precedents that the bank has based its decision on?
Answer: At present, majority of private sector banks/NBFCs/HFCs in India are following risk-based pricing based on internal risk rating models/bureau score.