Screening borrowers using new credit scoring technologies is a solution to overcome bad loans
Credit scores rate a borrower’s creditworthiness, based on their past history of financial transactions
Indian banks, especially public sector banks (PSBs), are struggling with bad loans. One solution is to screen borrowers better using new credit scoring technologies—but Indians banks have been slow to adopt these technologies. A new research paper by Prachi Mishra, Nagpurnanand Prabhala and former RBI governor Raghuram Rajan studies the rate of adoption of credit scoring to screen potential borrowers among Indian banks. They find that new private sector banks, such as HDFC Bank Ltd and Yes Bank Ltd, were more proactive in adopting credit scoring while PSBs lagged behind.
Credit scores rate a borrower’s creditworthiness, based on their past history of financial transactions. While these scores have been used globally for several decades, they only became popular in India around 2007 after legislation mandated banks report credit scores.
The authors analyse the rate of credit score adoption using a comprehensive data set on customer loans and data sets obtained from a major credit bureau in India. They find that the new private sector banks sought credit scores for all borrowers while PSBs only raised enquiries for new borrowers and not existing borrowers. These discrepancies continue to persist. In 2015, 90% of all loans by private sector banks are preceded by credit score enquiries, nearly double the usage rates by PSBs. Crucially, the authors find that lending without enquiries increased the risk of default. The authors argue that the slow adoption of credit scores for existing borrowers could be a consequence of the state ownership of PSBs that may not incentivize efficiency.
However, they also find a similar pattern in old private sector banks which also lagged behind in technology adoption. The authors conclude by saying that increased adoption of credit scoring technology by private sector banks will spur the PSBs to do the same due to increased competition.