Have you ever wondered how banks decide whether to approve or reject a loan application? Or why some people get better loan terms while others struggle to secure credit? The answer lies in credit scoring.
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- The meaning and types of risk in banking
- What is credit risk and why it matters
- How banks use credit scoring models to assess loan applications
- The role of credit information companies in India
- Strategies to improve and maintain a healthy credit score
👉 Before we dive in, watch this video for a complete breakdown:
Understanding Risk in Banking
What is Risk?
Risk is the possibility of loss due to uncertain events. In banking, risk arises when a borrower fails to repay a loan, leading to financial loss for the lender.
Example:
ABC Bank lends ₹10 lakh to a borrower. If there is a 20% chance that the borrower will default, the bank is exposed to credit risk.
Types of Risk in Banking
- Credit Risk – The risk that a borrower fails to repay the loan.
- Business Risk – The risk of loss due to poor business strategies.
- Market Risk – Losses due to interest rate changes or market fluctuations.
- Operational Risk – Losses due to system failures, fraud, or process inefficiencies.
- Liquidity Risk – The risk that a bank does not have enough cash to meet its obligations.
- Reputational Risk – The risk that a bank’s credibility is harmed, affecting its customer trust.
What is Credit Scoring?
Why is Credit Scoring Important?
Banks cannot eliminate risk completely, but they can manage it effectively using credit scoring.
Credit scoring is a statistical analysis that helps lenders determine a borrower’s creditworthiness based on their past financial behavior.
Factors Affecting Credit Score
- Payment History – Timely payments improve scores.
- Credit Utilization – Lower utilization rates are better.
- Length of Credit History – Longer histories improve scores.
- Types of Credit – A mix of different credit types is beneficial.
- Recent Credit Inquiries – Too many inquiries can lower scores.
Strategies to Improve Your Credit Score
- Pay EMIs & Credit Card Bills on Time – Avoid late payments.
- Keep Credit Utilization Below 30% – Lower utilization increases trust.
- Check Your Credit Report Regularly – Identify errors and correct them.
- Limit New Credit Applications – Too many inquiries lower scores.
- Maintain a Healthy Credit Mix – Balance secured and unsecured loans.
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Conclusion
Understanding credit scoring is essential for both bankers and borrowers. A high credit score can help you secure better loans, lower interest rates, and financial stability.
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