A Quantitative Approach to Credit Risk Management in the Underwriting Process for the Retail Portfolio

Abstract

The core of this paper encloses a mathematical approach of credit risk management, based on a scorecard model used in the bank’s underwriting process. The main purpose of this paper is to present how to develop, validate and apply a rating model in practice. Using 21568 loan applications provided by one of the largest banks from Romania, a scorecard is built for the underwriting purposes. The customer data used in the modeling is based on socio-demographic characteristics. The model is developed according to a set of statistical methods for parameter estimation. A real-life example of how to use such a model in the strategic decisions of a bank is presented. The cut-off score for the acceptance of the applications is calibrated to a potential risk appetite of the main four banks in Romania. From an evaluative perspective, this paper is compatible with an exploratory approach to quantitative research methodology.

Keywords

• Credit risk management
• Basel III
• Retail Scorecard
• Cut-off calibration