In a keynote address by Dr K C Chakrabarty, Deputy Governor of the Reserve Bank of India, at the Training Workshop on Credit Scoring Model (Mumbai Nov. 29th, 2013), stated that credit scoring offers a modern alternative for the traditional method of evaluating loans for small businesses where loans were approved on the basis of the banker’s qualitative judgment and the financial conditions carried significant weight in the appraisal process.

The Deputy Governor emphasized the difference between credit scoring and credit rating.   These are two are entirely distinct concepts and to be employed in distinctly different scenarios.  The credit score is an automated process based on a statistical technique that compbines several pre-determined characteristics to form a single score to assess a borrower’s credit worthiness.  Credit rating is a more appropriate tool for larger, mid-segment or corporate loans which have relevant financial data / business plans that provide the basis for futher credit analysis and information.  While credit scoring is an automated process, credit rating involves considerable amount of human involvement (rating experts/rating committees).

India’s MSME sector appears to be poorly served by financial institutions.  According to the statistics compiled in the Fourth Census of MSME sector revealed that only 5.18% of the registered and unregistered companies had availed of finance through institutional sources.  2.05% had finance from non-institutional sources and the majority of companies had no finance or depended on self-finance.

The Deputy Governor re-emphasized that given the extent of exclusion in the MSME sector and the criticality of the sector for the economy, banks urgently need to step up lending to the sector. For evaluating loan proposals and for facilitating MSME financing, banks would need to employ low cost and quick decision making alternatives.  The use of credit scoring models can go a long way in facilitating lending decisions by reducing costs and increasing service levels, which can deliver great benefits for both the lenders and MSE borrowers.  He also felt that “the conference would have been well served if we are able to bring about a change in mindset and willingness of the banks about the way they view MSME financing. If banks consider lending to SMEs to be a viable business proposition and show the willingness and determination to expand credit coverage to this sector, then credit scoring models can be employed effectively to achieve this objective in a meaningful way. This promises to be a win-win proposition for all the stakeholders: the small and medium enterprises, the lending financial institutions and the overall economy. “

To read the full speech please click on this link.

Source: BIS Central Bankers’ Speeches