Development and application of consumer credit scoring models using profit-based classification measures

Abstract

This paper presents a new approach for consumer credit scoring, by tailoring a profit-based classification performance measure to credit risk modeling. This performance measure takes into account the expected profits and losses of credit granting and thereby better aligns the model developers' objectives with those of the lending company. It is based on the Expected Maximum Profit (EMP) measure and is used to find a trade-off between the expected losses -driven by the exposure of the loan and the loss given default -and the operational income given by the loan. Additionally, one of the major advantages of * NOTICE: this is the author's version of a work that was accepted for publication in the European Journal of Operational Research. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. Please cite this paper as follows: Verbraken, T., Bravo, C., Weber, R. and Baesens, B. (2014) Development and application of consumer credit scoring models using profit-based classification measures. European Journal of Operational Research. In Press. Available Online: http://www.sciencedirect.com/ science/article/pii/S0377221714003105 † Email Addresses: thomas.verbraken@kuleuven.be, crbravo@utalca.cl (corresponding), rweber@dii.uchile.cl, bart.baesens@kuleuven.be 1 using the proposed measure is that it permits to calculate the optimal cutoff value, which is necessary for model implementation. To test the proposed approach, we use a dataset of loans granted by a government institution, and benchmarked the accuracy and monetary gain of using EMP, accuracy, and the area under the ROC curve as measures for selecting model parameters, and for determining the respective cutoff values. The results show that our proposed profit-based classification measure outperforms the alternative approaches in terms of both accuracy and monetary value in the test set, and that it facilitates model deployment.

The use of profit scoring as an alternative to credit scoring systems in peer-to-peer (P2P) lending

“…Other studies develop profit scoring for credit cards and consumer credit [12,13,14,15,16,3]; however, the lack of data resulted in the use of customer profit proxies. To the best of our knowledge, there are no previous studies using the IRR as a dependent variable.…”

A Robust profit measure for binary classification model evaluation

“…Verbraken et al (2013) developed a stochastic version of the MP measure, called the EMP, which models each cost using a probability distribution, allowing the estimation of the expected value of the maximum profit. The MP and EMP measures have been implemented and adopted successfully in churn prediction (Verbraken et al, 2014b) and credit scoring (Verbraken et al, 2014a). Both the MP and EMP measures are discussed in more detail in the next section.…”

“…This cost is considered relative to the amount of the requested loan (A) and will be assumed to be constant across cases (Verbraken et al, 2014a).…”

“…Credit scorecards, especially application scorecards, are classification models that are typically developed for making this decision in a data-driven manner (Thomas et al, 2002;Siddiqi, 2016). By defining the cost and benefit parameters and establishing the involved profit formula, Verbraken et al (2014a) adapted the EMP measure as defined in Equation (4) to evaluate credit scorecards:…”

“…Some applications of these measures include determining the optimal fraction of the consumers to be targeted for a churn prevention campaign at a telecommunications company (Verbeke et al, 2012) and estimating the maximum profit of credit scoring models (Verbraken et al, 2014a). This paper presents a more robust version of the measure for the case in which the uncertainty comes not only from the profit parameters but also from external random shocks, which we call the Robust Expected Maximum Profit (R-EMP) measure.…”