Why FICO is the Most Effective Scoring System in Lending

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As more countries adopt credit scoring systems, the original credit score still stands above the rest.

Modern credit scoring assigns a specific, comparable number to each person’s creditworthiness, allowing lenders to make more informed decisions about which loans to make and what interest rate to charge.

What’s in FICO?

The FICO score considers multiple weighted factors to create an individual’s FICO score.

  • Payment history: making past payments on time
  • Amount owed: total debt as well as debt relative to credit limit
  • Length of credit history: the length of time you have had credit in that jurisdiction
  • New credit: the number of times you recently applied for new credit
  • Credit mix: the mix of credit cards, bank loans, student loans and mortgages

The first of these was devised by Bill Fair and Earl Isaac in the US in 1956. The multivariate, statistical underwriting models built by FICO (originally Fair, Isaac and Company) allowed lenders to make more nuanced decisions about individual borrowers without having to rely on the highly subjective, and often poorly informed, judgments of bank loan officers. There are three national credit bureaus in the US: Equifax, TransUnion and Experian and they capture, update and store credit histories on the majority of US consumers.

FICO scores are calculated based upon information the credit bureaus keep on file about each US consumer and by comparing this information to the patterns in the hundreds of past credit reports, FICO scores also estimate the level of future credit risk. FICO’s positive credit rating scores were a marked improvement on so-called negative credit systems, which identified the creditworthiness of individuals but were basically blacklists of individuals that had defaulted or had late payments.

What’s in FICO?

The FICO score considers multiple weighted factors to create an individual’s FICO score.

  • Payment history: making past payments on time
  • Amount owed: total debt as well as debt relative to credit limit
  • Length of credit history: the length of time you have had credit in that jurisdiction
  • New credit: the number of times you recently applied for new credit
  • Credit mix: the mix of credit cards, bank loans, student loans and mortgages

In the decades since FICO was founded, personal consumption has taken a larger role in global economic growth, creating demand for consumer credit scoring systems around the world. The UK, China, Australia, Canada, Hong Kong, Singapore, Malaysia, India and more all have internal credit systems for consumers. However, these systems differ significantly in terms of the depth and maturity of the data as well as how the credit is analyzed.

International comparison

Australia

  • Agencies: Equifax (1967); illion (1887); Experian (1998)
  • Factors: demographics; joint applications; credit applications; arrears; defaults; debt agreements; commercial and business loan applications
  • Strengths/weakness: Prior to 2014, Australia only adopted negative credit system and the positive credit score system was introduced widely since 2016. The history of the credit score system is relatively young in Australia. While there is no unified credit score provider, each credit bureau may adopt varying methodologies.

China

  • Agencies: China Credit Reference Center (2013)
  • Factors: demographics; payment history, public records, number of inquiries
  • Strengths/ weaknesses: China does have positive credit rating, however, the access to such information is only limited to authorized financial institutions and the data is only collected through financial institutions. Although there are private companies that have developed credit scoring systems, it is not connected with the government credit scoring system.

Hong Kong

  • Agencies: TransUnion (1982)
  • Factors: Payment history; balance owed; credit history; credit mix; number of inquiries
  • Strengths/ weaknesses: Hong Kong’s credit scoring system is comprehensive and has high coverage, but it does not go back as far as the US. Also, the total market size is smaller given the population size of Hong Kong.

Japan

  • Agencies: Personal Credit Information Center (1988); Credit Information Center (1984); Japan Credit Information Reference Center (1986)
  • Factors: credit history; defaults and late payments; current account history
  • Strengths/ weaknesses: Japan’s credit rating agencies have a few decades of coverage, but they are highly fragmented, despite an attempt to unify reporting through the Credit Information Network.

Singapore

  • Agencies: Consumer Credit Bureau (2002)
  • Factors: demographics; number of inquiries; credit repayment from last 12 months; default records; bankruptcy records; litigation records
  • Strengths/ weaknesses: Singapore’s credit rating system is centralized and comprehensive, however, it is less than 20 years old, making the data less valuable for predictive risk modeling.

UK

  • Agencies: Experian (1900); Equifax (1990); TransUnion (2000)
  • Factors: Credit history and utilization; number of inquiries; public records; current account provider
  • Strengths/ weaknesses: Credit scoring is closely regulated in the UK but there is no universal credit score or credit rating on individuals in UK. Each lender, including all banks, may have its own complexity and structure of credit scores and the most commonly adopted one is for a negative credit system to predict a binary outcome.

Strengths of US system

While each of these consumer credit rating systems has unique domestic challenges to address, they all still have material deficiencies, when compared to the US credit rating system. The US credit rating system is the oldest positive credit rating system, and it has wide coverage of the population. The US credit rating system is also based around a single methodology, as each of the three credit rating agencies uses FICO as the basis of their scores.

Another strong point for the US credit rating system is that all major consumer financial institutions report to all three agencies. This means that there are minimal information gaps between the agencies, which results in high confidence for lenders and fairer scores for individuals.

In addition, one clear advantage of the US credit rating system is the sheer size of the US consumer lending market. Totaling nearly US$4 trillion in May 2018, according to US Federal Reserve data, the US consumer credit market is very deep and contains a broad range of consumer lending products, such as credit cards, personal loans, mortgages and lines of credit. This depth gives additional depth to the pool of data that credit rating agencies can analyze to improve their models.

While other countries’ systems may be on the right track to achieve similar status, the US consumer credit rating system is set to stand above them all for many years to come.

To learn more about how FinEX Asia’s consumer credit funds utilize FICO data, register today.

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