Featured Product

    IMF Paper Examines Application of Machine Learning in Assessing Credit

    May 17, 2019

    IMF published a working paper on application of machine learning in assessing credit risk. This paper reviews the underlying challenges in assessing credit risk of particularly small borrowers and discusses the most prominent machine learning techniques applied in assessing credit risk of borrowers for a nontechnical audience.

    The paper examines potential strengths and weaknesses of machine-learning-based credit assessment by presenting core ideas and the most common techniques in machine learning for the nontechnical audience; it also discusses the fundamental challenges in credit risk analysis. The paper presents the main elements of prudent lending in the context of the five Cs of credit and agency problems.  The five Cs of credit are capacity, capital structure, coverage, character, and conditions. The paper also discusses main machine learning tools and techniques and examines the strengths and weaknesses of machine learning-based lending in contrast with the traditional methods. 

    The paper highlights that machine learning has certain weaknesses that should be taken into consideration when applying for credit risk assessment:

    • Heavy reliance on learning from data, particularly in a context where the size of the sample is considerably larger than traditional ways of credit scoring, could result in noisy information playing a role in driving results of credit analysis and leading to financial exclusion of creditworthy applicants. The bias in the sample should be identified and avoided by analysts as much as possible to avoid digital financial exclusion.
    • Machine learning may not capture structural changes in a timely manner, because arrival of informative data may be slow due to the lengthy process of default observation. This could negatively impact fintech lenders that rely on machine learning to assess borrowers without evaluating the relevance of data used for training the model for new applicants. 
    • Borrowers may realize and counterfeit certain indicators that drive their credit score, thus decreasing the relevance of those features for new applicants.
    • Machine learning is exposed to some of the key concerns in econometrics, most importantly the endogeneity and selection bias problem. The analyst should check the sample to ensure proper treatment of these issues and avoid superfluous results. Nonetheless, proper choice of risk drivers makes these issues less of a concern for credit risk assessment and default outcome prediction.

    Overall, the paper concludes that fintech credit has the potential to enhance financial inclusion and outperform traditional credit scoring by leveraging nontraditional data sources to improve the assessment of the borrower’s track record, appraising collateral value, forecasting income prospects, and predicting changes in general conditions. Nevertheless, the emerging market economies may face some challenges in reaping the benefits while ensuring that the development of fintech credit does not expose systemic risks to the financial system. Given the central role of data in machine-learning-based credit analysis, it should be legally and technologically possible to gather digitalized data reliably from various sources and avoid noisy and biased data as much as possible. As a complement for high-quality data availability, cyber-security measures should be in place because of the sensitivity of credit information. Moreover, the machine learning analysts should consistently review machine learning models for credit rating to avoid potential weaknesses of naive application of machine learning. 

     

    Related Link: Working Paper

     

    Keywords: International, Banking, Financial Inclusion, Fintech, Machine Learning, Credit Risk, Big Data, Systemic Risk, IMF

    Featured Experts
    Related Articles
    News

    APRA Finalizes Reporting Standard for Operational Risk Requirements

    APRA finalized the reporting standard ARS 115.0 on capital adequacy with respect to the standardized measurement approach to operational risk for authorized deposit-taking institutions in Australia.

    March 03, 2021 WebPage Regulatory News
    News

    ESAs Issue Advice on KPIs on Sustainability for Nonfinancial Reporting

    ESAs Issue Advice on KPIs on Sustainability for Nonfinancial Reporting

    March 01, 2021 WebPage Regulatory News
    News

    EBA Consults on Pillar 3 Disclosure Standards for ESG Risks Under CRR

    EBA is consulting on the implementing technical standards for Pillar 3 disclosures on environmental, social, and governance (ESG) risks, as set out in requirements under Article 449a of the Capital Requirements Regulation (CRR).

    March 01, 2021 WebPage Regulatory News
    News

    EU Amends CRD4 and CRD5 as Part of Capital Markets Recovery Package

    EU published Directive 2021/338, which amends the Markets in Financial Instruments Directive (MiFID) II and the Capital Requirements Directives (CRD 4 and 5) to facilitate recovery from the COVID-19 crisis.

    February 26, 2021 WebPage Regulatory News
    News

    EBA Publishes Single Rulebook Q&A Updates in February 2021

    The EBA Single Rulebook question and answer (Q&A) tool updates for this month include answers to ten questions.

    February 26, 2021 WebPage Regulatory News
    News

    ESMA Releases Schema and Instructions for Securitization Reporting

    ESMA updated the set of questions and answers (Q&A), along with the reporting instructions and an XML schema for the templates set out in the technical standards on disclosure requirements, under the Securitization Regulation.

    February 26, 2021 WebPage Regulatory News
    News

    EU Rule Amends Requirement for European Single Electronic Format

    EU published Regulation 2021/337, which amends the Transparency Directive (2004/109/EC), regarding the use of the single electronic reporting format for annual financial reports.

    February 26, 2021 WebPage Regulatory News
    News

    EU Committee Recommends Systemic Risk Buffer of 4.5% in Norway

    The Standing Committee of the European Free Trade Association (EFTA) recommended that a systemic risk buffer level of 4.5% for domestic exposures can be considered appropriate for addressing the identified systemic risks to the stability of the financial system in Norway.

    February 25, 2021 WebPage Regulatory News
    News

    PRA Clarifies Approach to Onshoring of Credit Risk Rules for UK Banks

    In a recent statement, PRA clarified its approach to the application of certain EU regulatory technical standards and EBA guidelines on standardized and internal ratings-based approaches to credit risk, following the end of the Brexit transition.

    February 25, 2021 WebPage Regulatory News
    News

    FSB Sets Out Work Priorities for 2021

    In a recently published letter addressed to the G20 finance ministers and central bank governors, the FSB Chair Randal K. Quarles has set out the key FSB priorities for 2021.

    February 25, 2021 WebPage Regulatory News
    RESULTS 1 - 10 OF 6637