It’s time to implement risk-based loan pricing

By Harshala Chandorkar

Rewarding good is an age-old practice. If you’ve paid off your credit card dues and loans on time, you’re a good customer. And if the aforementioned adage is followed, you might expect to be rewarded with a lower interest rate the next time you apply for a loan. This practice of rewarding good customers has not yet been accepted by credit institutions in the country.

To ensure that good customers are rewarded for their financial discipline, it would be desirable for all credit institutions and banks in the country to adopt credit score-based loan pricing.

Cheaper credit for good borrowers
Since a bank determines a reasonable probability of default and provisions for it based on credit history, borrowers with a good credit history can be rewarded for their responsible financial behavior. By using risk-based pricing, the borrower with better credit can earn a lower interest rate on a loan, reflecting the lower expected losses the bank will incur. Risk-based loan pricing is a system of offering credit at a rate depending on the customer’s credit rating. For example, lenders may offer you a higher interest rate if you are considered a higher risk borrower i.e. your credit score is low according to banks’ lending policies. For the same loan amount, lenders are likely to offer a lower interest rate if your score is high. Since the CIBIL score ranges from 300 to 900, the higher the score, the better the chances of getting cheaper loans and credit instruments.

Based on the analysis of CIBIL data, we observed that most banks lend to individuals with a credit score of 750 and above. In more developed markets like the United States, clients with different credit scores are categorized as Senior, Subprime, and Alt A borrowers. Lenders charge varying rates of interest depending on the risk category of those borrowers. borrowers. Typically, a credit bureau in the United States defines those with a credit score of less than 660 as subprime borrowers, and these borrowers are often charged at a higher rate than prime rate borrowers. Such categorization and risk-based pricing has yet to evolve in India.

However, some progressive institutions like the Bank of Baroda have started offering credit score based loans to retail mortgage applicants, which involves providing a differential interest rate based on the borrower’s CIBIL score. . Customers with a good loan repayment history and strong finances can get loans at least 50 to 75 basis points cheaper than a customer with a bad credit rating. It will also encourage the customer to maintain consistent credit behavior and increase their CIBIL score to benefit from lower rates. It should also stimulate the growth of banks’ personal loan portfolios, making it a win-win situation for both parties.

Promote credit awareness and discipline
Several World Bank reports and case studies have shown that a risk-based pricing environment based on credit information data improves loan performance by reducing default rates and contains non-performing assets . Credit penetration is achieved by significantly identifying “good borrowers” (low credit risk) who otherwise would have been misidentified as “bad borrowers” (high credit risks) and, therefore, might not have obtained credit on optimal terms. At the same time, high risk borrowers are no longer subsidized by low risk consumers. Risk-based loan pricing could be a major motivator for retail clients to ensure they maintain a healthy credit history and high credit rating.

The availability of CIBIL’s credit information information and solutions has significantly helped drive growth in the retail credit segment while fueling credit penetration and financial inclusion. Analysis of CIBIL data reveals that retail loans have grown at an average CAGR of 28% over the past three years, while at the same time there is a significant reduction in retail NPA rates. Credit reporting solutions have also helped reduce the average time it takes to approve a loan application – from about 7-9 days three years ago to about 3-4 days today.

The use of CIBIL’s information solutions has contributed to the growth of rural lending – inquiries about the rural lending office were around 25% five years ago and have steadily increased to almost 35% today. Lenders have benefited from increased volumes, greater efficiency and lower acquisition costs while minimizing risk, and consumers have benefited from greater convenience, faster approvals and easier access to credit.

Risk-based loan pricing helps both lenders and borrowers, as lenders can assess a client’s risk value before deciding to offer a loan at a particular rate, while clients with a Higher CIBIL score benefit from lower rates compared to clients with low scores. The benefits thus ensure that customers strive to keep their scores and creditworthiness high.



The opinions expressed above are those of the author.


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