Financial Update (Third Quarter 2007)

Fed Report: Credit Scoring Likely Contributor to Affordable Credit

credit scoreCredit scoring emerged in the late 1950s to support lending decisions by the credit departments of large retail stores and finance companies. By the end of the 1970s, most of the nation's largest commercial banks, finance companies, and credit card issuers used credit-scoring systems.

Indeed, credit scoring helped make possible today's large-scale, open-ended consumer lending, that is, the extension of significant numbers of small loans, including credit cards.

New Fed study cites scoring's advantages
The Federal Reserve recently submitted a report to Congress on credit scoring and its effects on the availability and affordability of credit.

Credit scoring report
Federal Reserve credit resources

The following are among the report's key findings:

  • Credit scoring, as a cost- and time-saving technology, likely has contributed to improved credit availability and affordability over the past 25 years. However, the report includes the caveat that because credit scoring has been employed for many years, just how much credit scoring has helped perpetuate affordable credit is difficult to gauge;
  • The increase in credit availability appears to hold for the population overall as well as for major demographic groups, including different races and ethnicities. There is no compelling evidence, however, that credit scoring has caused any particular demographic group to experience markedly greater changes in credit availability or affordability than other groups;
  • Credit history scores have accurately predicted credit risk for the overall population and for all major demographic groups—the better the score, the lower the observed incidence of loan default; and
  • Different demographic groups have substantially different credit scores, on average. For example, on average, African-Americans and Hispanics have lower credit scores than non-Hispanic whites and Asians, and individuals younger than 30 have lower credit scores than older individuals.

Scoring has contributed to credit affordability
"In all likelihood," the Fed study indicates, "making such loans at the rates they are offered today would not have been possible had it not been for the advances in credit scoring, which have dramatically reduced the cost of offering such credit."

Similarly, credit-scoring technologies in the 1990s lowered the costs of underwriting and funding home mortgages and promoted greater competition, according to the report.

September 21, 2007