Rewarding the good has been an age-old practice. If you have been paying back your credit card dues and loans on time, you are a good customer. And if the aforementioned adage is followed, you could expect to be rewarded with a lower rate of interest the next time you apply for a loan. This practice of rewarding good customers is yet to gain acceptance by the country’s lending institutions.
To ensure that good customers are rewarded for their financial discipline, it would be advisable that all credit institutions and banks in the country adopt credit score-based pricing of loans.
Cheaper credit for good borrowers
Since a bank determines a reasonable default probability and provisions for it based on past credit history, borrowers with good credit histories can be rewarded for their responsible financial behavior. Using risk-based pricing, the borrower with better credit can get a lower rate of interest on a loan as a reflection of the expected lower losses the bank will incur. Risk-based pricing of loans is a system of offering credit at a rate depending on the customer’s credit score. For instance, lenders may offer a higher rate of interest to you if you are viewed as a higher risk borrower, i.e. your credit score is low as per the banks’ lending policies. For the same loan amount, lenders are likely to offer a lower rate of interest if your score high. Since the CIBIL score ranges from 300 to 900, the higher the score, better are the chances of getting cheaper loans and credit instruments.
Based on CIBIL data ****ysis, we have observed that most banks are lending to individuals with a credit score of 750 and above. In more developed markets like the US, customers with different credit scores are categorized as prime, subprime and Alt A borrowers. The lenders there charge varying interest rates as per the risk category of such borrowers. Typically, a credit bureau in the US defines those with credit scores below 660 as subprime borrowers, and such borrowers are often charged a higher rate than prime ones. Such categorization and provision of risk-based pricing have yet to evolve in India.
However, some progressive institutions started offering credit score-based lending to retail mortgage loan seekers, which involves providing differential rate of interest based on the borrower’s CIBIL score. Customers with a good loan repayment track record and strong financials may get loans which are at least 50-75 basis points cheaper than a customer with a bad credit score. It will also provide an incentive to the customer to maintain consistent credit behavior and increase his/her CIBIL score to get the benefit of lower rates. This is also likely to boost growth of the retail loan portfolios of banks, thus making it a win-win situation for both parties.
Promote credit consciousness 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 delinquency rates and contains non-performing assets. Credit penetration is achieved by significantly identifying “good borrowers” (low credit risk) that otherwise would have been misidentified as “bad borrowers” (high credit risks) and, therefore, may not have been provided credit at optimal terms and conditions. At the same time, high-risk borrowers are no longer subsidized by lower-risk consumers. Risk-based pricing of loans could be a major motivating factor for retail customers to ensure they maintain a healthy credit history and a high credit score.
Availability of credit information insights and solutions from CIBIL has significantly contributed to driving growth in the retail credit segment while fuelling credit penetration and financial inclusion. CIBIL data ****ysis reveals that retail loans have grown at an average CAGR of 28% over the last three years, while, at the same time, there is significant reduction in retail NPA rates. Credit information solutions have also helped reduce the average time required for approval of a loan application- from approximately 7-9 days three years back to around 3-4 days today.
Usage of information solutions from CIBIL has contributed to the growth in rural lending- enquiries on the bureau for rural lending was around 25% over five years back and have steadily grown to almost 35% today. Lenders have benefited from increased volumes, higher efficiencies and lower costs of acquisition while minimizing risk and consumers have benefited with the increased convenience, faster approvals and easier access to credit.
Risk-based pricing of loans and getting best home loan helps both the lenders and borrowers alike as the lenders can assess the risk value of a customer before deciding to offer a loan at a particular rate, while customers with a higher CIBIL score benefit by getting lower rates as compared to customers with a low scores. The benefits thus ensure that the customers work towards keeping their scores and credit worthiness high.