How do credit scoring models help merchants make better decisions?

1 Types of credit scoring models

Merchants can choose from different types of credit scoring models depending on their needs and objectives. Generic models, such as FICO and VantageScore, are based on data from a large and diverse population of borrowers and customers, providing a general score that reflects an individual's or business's creditworthiness. Custom models, developed by merchants or lenders for their specific products, markets, or segments, use data from their own customers or applicants as well as external sources and can be more accurate. Hybrid models combine generic and custom models to leverage the strengths of both approaches. These models may use generic scores as inputs or benchmarks, then adjust them with custom factors or weights.

2 Benefits of credit scoring models

Credit scoring models can provide merchants with objective and consistent information about their potential and existing customers, which can help them make better decisions. Credit scoring models can reduce risks by identifying customers who are more likely to default, chargeback, or commit fraud, as well as setting appropriate credit limits, interest rates, fees, and terms. Additionally, they can increase sales by offering credit or payment options to customers who may not qualify for traditional financing or have limited access to credit. Moreover, credit scoring models can improve customer relationships by making faster and fairer decisions, reducing manual reviews and errors, providing clear and transparent communication, and showing customers their scores and how they can improve them. This can help merchants build trust and rapport with their customers.

3 Challenges of credit scoring models

Credit scoring models are not perfect and merchants need to be aware of the limitations and challenges they present. Data quality and availability is an issue, as credit scoring models rely on data to generate scores, but data can be incomplete, outdated, inaccurate, or biased. Model development and validation is also complex and requires expertise and resources. Additionally, credit scoring models must comply with various laws and regulations that protect the rights and privacy of consumers and prevent discrimination. Merchants must ensure that they have access to relevant and high-quality data sources, understand their objectives, assumptions, and methodologies, test and evaluate their models periodically, and use credit scoring models in a responsible and ethical manner.

4 Best practices for credit scoring models

Credit scoring models can be useful for merchants to make better decisions, but they must be implemented and managed strategically. Before using credit scoring models, merchants should define their goals and criteria for credit or payment decisions, such as target market, risk appetite, expected return, and customer experience. Additionally, merchants must choose the type and provider of credit scoring models that best suit their needs and objectives. This could include generic, custom, or hybrid models, or a combination of them; working with external or internal providers; or both. Furthermore, merchants should monitor and review their results and performance regularly to ensure they are meeting their goals and criteria. This includes approval rates, default rates, customer feedback, and profitability. They should also compare their results with competitors and industry benchmarks. Finally, based on the results and performance, merchants should update and improve their models and data periodically by adding new data sources, adjusting factors or weights, changing methodologies or algorithms, validating data for accuracy and reliability.

5 Examples of credit scoring models in action

Credit scoring models can be used by merchants in different scenarios and industries to make better decisions. For example, e-commerce merchants can use credit scoring models to offer buy now pay later (BNPL) options to their customers, which allow them to pay in installments or after delivery. This helps the merchant assess the customer's ability and willingness to pay, as well as set the appropriate payment terms and conditions. Banking merchants can use credit scoring models to offer loans, credit cards, or overdrafts to their customers, which provide them with access to credit and liquidity. This helps the merchant determine the customer's creditworthiness and risk level, as well as set the appropriate credit limit and interest rate. Similarly, insurance merchants can use credit scoring models to offer policies, premiums, or claims to their customers, which protect them from financial losses or damages. This helps the merchant estimate the customer's likelihood of filing a claim or defaulting on a premium, and set the appropriate coverage and price.

6 Here’s what else to consider

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