What is credit scoring?

Reliable forecasts of customers' future payment behaviour are important for companies in all industries. Credit scoring is designed to support this. Credit scoring yields a numeric value, which is also called a score. Based on a statistical analysis, credit scoring provides an index to the creditworthiness or the solvency of a given person. So, in other words, credit scoring can also be described as a standardised and automated procedure to determine a credit rating index.

 

How credit scoring works

Credit scoring collects relevant events and data from the past. On this basis, the likelihood of similar events occurring in the present or future is calculated. This is always based on certain personal characteristics which are relevant for credit provision and includes data on negative payment behaviour in the past, outstanding loans, information from the debtors' register - as well as statistical values. However, personal and factual customer characteristics are not included in the Informa-consumer-Score provided by infoscore Consumer Data GmbH. 

Individual characteristics are assessed and then weighted with regard to each other. Companies can carry out credit scoring using their own data. In addition, they can also access information from credit agencies, such as infoscore Consumer Data GmbH. Depending on the data volume, selection and weighting, different results are established in the process. The score established by credit agencies also depends on the purpose for which an inquiry is submitted. Under certain circumstances, a mail order company might receive a different value for credit scoring than would an insurance company. The compilation of rules and calculation methods applied in credit scoring is called a score card.

How credit scoring is used

Standardised credit scoring plays a role whenever a transaction is exclusively based on the customer's solvency. Credit scoring is used in all types of credit transactions. These include more than just conventional bank loans. In the mail order business, credit transactions also play a role, e.g. if a customer orders goods payable on receipt of invoice. Until the invoice is paid, the company grants its customers a loan. To cover this risk, many mail order companies use credit scoring. Moreover, it is also used for mobile-phone contracts and in the insurance industry.

The score calculated during credit scoring facilitates a company's decision as to whether a given credit transaction is sensible. In many cases, a decision on payment terms or interest rates and collateral is also taken on the basis of credit scoring. Credit scoring is always aimed at reducing risks and at making decisions on as objective a basis as possible. Credit scoring models can be evaluated based on how reliably their results can be applied to reality. An algorithm which is too optimistic might lead to payment default. If, on the other hand, the algorithm for calculating the credit score is too pessimistic, the company might lose solvent customers. The advantages of credit scoring include the fact that the procedure facilitates fast classification and processing. As a result, customers can lower their risk management costs and also pass on this advantage to their customers in the form of lower prices.

Legal provisions on credit scoring

The Federal Data Protection Law (BDSG) couples the use of credit scoring to certain conditions. Credit scoring is permitted as a decision-making tool for taking up, modifying or terminating a business relationship. However, for this purpose, the exclusive use of address data is not allowed. Also, the person concerned must be informed of the fact that their address data are used.

Credit scoring by credit agencies is subject to the BDSG provision regarding justified interest. As a result, the credit scores and the underlying data may only be communicated if there is a legitimate interest, such as an initial business contact or an order for goods placed on the Internet.  

Another statutory provision for credit scoring is a self-report according to section 34 BDSG. According to this, credit agencies are required to provide a free self-report to consumers once a year. This report informs consumers about the data saved regarding themselves and about the credit scores which were forwarded to inquiring companies. Infoscore Consumer Data GmbH can also provide a free report to you once a year. This requires a written request. For data protection reasons, this information cannot be requested via phone or e-mail.