The use of credit scoring in the mortgage industry

Abstract

In times of increased focus on risk management, acquiring or growing comparatively low risk mortgage portfolios has become an attractive value proposition. Banks that pursue an aggressive growth strategy in this sector, do, however, require risk control mechanisms that enable them to make a clear judgment on how great a growth appetite they can afford to have in order to still grow profitably. Moreover, under Basel II, the proper quantification of mortgage portfolio risk tends to help the release of own capital, because the mortgage portfolio is one of those portfolios where the relative benefits of internal ratings-based approaches compared with the standardised approach are greatest. Credit scoring models in general, and credit scorecards in particular, are suitable methods for quantifying the risk of an individual mortgage applicant or mortgage customer. In addition to score card development, this paper reviews alternative scoring model types that could be used for mortgage scoring. It presents reasons why it is beneficial to build such models in-house, before focusing on the steps necessary for building a mortgage scorecard. Finally, it discusses the important topics of creating segments, deploying models and eventually monitoring models.