Building a Credit Scoring System

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Building a Credit Scoring System

Estimating credit risk level in a credit scoring system is based on scoring factors covered by model. Scores are defined according to normative point scales . As normative can be considered (Sierpi, 1998):

average results in a chosen branch
model values
previous results of the enterprise

Added characteristic scores make the synthetic estimation of the area. All the considered areas' estimations make the total score that defines the economic-financial position class.

Building a Traditional Scoring System

The building scoring system process can be split into several stages:

defining aims and assumptions of the system ^[4]
collecting data of through-the-door population (Janc & Kraska, 2001)
analyzing data and defining a model (set of characteristics and their attributes)
constructing scoring tables
verification of tables.

More information on aspects of building a scoring system can be found in literature (Janc & Kraska, 2001). The scoring tables we present in Tables 5 through 11 are in use in one of the biggest Polish banks. The normatives are changed periodically.

Table 5: The scoring table for the "profitability" area (normative point scale)
Profitability
criteria		very good		good		medium		weak		bad
criteria		current value	Pt	current value	Pt	current value	Pt	current value	Pt	current value	Pt
1	ROS	ROS > 2S	7	2S>ROS>1S	5	1S>ROS>0,5S	3	0,5S>ROS>0	2	ROS < 0
2	ROA	ROA > 2A	5	2A>ROA>1A	4	IA>ROA>0,5A	3	0,5A>ROA>0	2	ROA < 0
3	ROE	ROE > 2E	5	2E>ROE>1E	4	1E>ROE>0,5E	3	0,5E>ROE>0	2	ROE < 0
Source: The authors, based on scoring methodology (one of 10 biggest Polish banks acc. to "Gazeta Bankowa")
ratios ROS, ROA, ROE—based on financial statements data for a new enterprise, calculations are based on forecast results and assumptions of business plan normative values of S, A, E are fixed by the headquarters of the bank

Table 6: The scoring tables for the rest of the objective factors areas

Financial liquidity
Criteria		Very good		good		medium		weak		bad
Criteria		Current Value	Pt	current value	Pt	current value	Pt	current value	Pt	current value	Pt
1	current ratio (CR)	x	7	x	5	x	3	x	2	x
2	quick ratio (QR)	x	7	x	5	x	3	x	2	x
^[a] Backing of credit repayment = (cash flow+interests)/(instalments+interests)—forecast.

Activity
Criteria		Very good		good		medium		weak		bad
Criteria		Current Value	Pt	current value	Pt	current value	Pt	current value	Pt	current value	Pt
1	avg. collection period	x	4	x	3	x	2	x	1	x
2	inventory turnover	x	4	x	3	x	2	x	1	x
3	total assets turnover	x	4	x	3	x	2	x	1	x
^[a] Backing of credit repayment = (cash flow+interests)/(instalments+interests)—forecast.

Indebtedness
criteria		very good		good		medium		weak		bad
criteria		current value	Pt	current value	Pt	current value	Pt	current value	Pt	current value	Pt
1	debt ratio	x	7	x	5	x	3	x	2	x
2	constant capital/fixed assets	x	5	x	4	x	3	x	1	x
3	backing credit repayment ^[a]	x	5	x	4	x	2	x	1	x
^[a] Backing of credit repayment = (cash flow+interests)/(instalments+interests)—forecast.

Table 7: Subjective factors, scoring tables

Reliability of the enteroreneur
criteria		high	good	weak	bad
criteria		Pt	Pt	Pt	Pt
1	reliability of an entrepreneur	4	3	1
2	previous relations with the Bank	4	3	1

Market position of an enterprise
criteria		high	good	weak	bad
criteria		Pt	Pt	Pt	Pt
1	sale possibilities	4	3	1
2	mark of product	4	3	1
3	Competition	3	2	1
4	customers / suppliers	2	1	1

Characteristics of the industry (branch)
criteria		high	good	weak	bad
criteria		Pt	Pt	Pt	Pt
1	progress level	3	2	1
2	technology	3	2	1

Management competence
criteria		high	good	weak	bad
criteria		Pt	Pt	Pt	Pt
1	experience and competence	5	3	2

Economic—Financial Position Class in Relation to Total Score

Table 8: The score corresponding to the class of the economic-financial position
economic-financial position class	score
A-1	90 – 100
B-2	74 – 89
C-3	57 – 73
D-4	40 – 56
E-5	below 40
Source: The authors, based on scoring methodology (one of 10 biggest Polish banks acc. to "Gazeta Bankowa")

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It is stated that current credit capacity of an enterprise is fulfilled under following conditions:

economic—financial position class—A-1, B-2, or C-3
score of both objective and subjective factors are not less than their minima: 3 5 and 15 points, respectively

Credit Risk Class in Relation to Economic—Financial Position Class

Table 9: The score corresponding to the class of the economic-financial position and the previous credit performance
credit risk class	previous credit performance
economic-financial position class	regular	1 – 3 months	3 – 6 months
A-1	I	II	III
B-2	I	II	III
C-3	II	III	III
D-4	III	III	IV
E-5	III	IV	IV
Source: The authors, based on scoring methodology (one of 10 biggest Polish banks acc. to "Gazeta Bankowa")

The Example of the Estimation of the Economic-Financial Position and the Estimation of Current Credit Capacity and Credit Risk Class Using Traditional Credit-Scoring Method

Table 10: Example—The score corresponding to factors
The enterprise	XXX	The branch	YYY
A	qualitative factors
	area / characteristic	value of the factors	score
I	profitability		12
1	return on sales [ROS]	0,69%	5
2	return on assets [ROA]	0,51%	3
3	return on equity [ROE]	0,80%	4
II	financial liquidity		14
1	current ratio	2,2	7
2	quick ratio	1,2	7
III	activity		8
1	avg. collection period	28	3
2	inventory turnover	39	3
3	total assets turnover	1,3	2
IV	Indebtedness		16
1	debt ratio	0,2	7
2	constant capital/ fixed assets	2	5
3	backing credit repayment	1,4	4
B	quantitative factors
	area / characteristic	score
I	reliability	6
1	Reliability of the entepreneur	3
2	previous relations with the Bank	3
II	market position of an enterprise	10
1	sale level	4
2	mark of product	3
3	Competition	2
4	customers / suppliers	1
III	character of the industry (branch)	5
1	progress level	2
2	Technology	3
IV	management competence	2
1	experience and competence	2

Table 11: The total score corresponding to qualitative and quantitative factors
			minimum
1	total score for quantitative factors	50	35
2	total score of qualitative factors	23	15
		73

Economic-financial class		C-3
	minimum score
1	quantitative factors	yes
2	qualitative factors	yes