Credit Scoring Systems Explained

C

The correct answer is C - both A and B.

Credit scoring systems are used by lenders and financial institutions to evaluate an applicant's creditworthiness. These systems use key attributes of the applicant and aspects of the transaction to determine whether an applicant is deemed creditworthy. The credit scoring process is usually automated and objective, and it considers a variety of factors such as the applicant's credit history, income, and debt-to-income ratio.

The credit scoring systems must also meet regulatory requirements and be evaluated by regulatory agencies to ensure they are empirically derived and statistically sound. This evaluation process examines the bank's policies on the use of the credit scoring system, the training of bank employees on the use of the system, and the number of high-side and low-side overrides of the system.

High-side overrides occur when a lender approves a loan even though the credit score is lower than the lender's predetermined threshold. Low-side overrides occur when a lender denies a loan even though the credit score is higher than the lender's predetermined threshold. The number of high-side and low-side overrides can indicate whether the credit scoring system is working effectively or whether there may be biases or errors in the system.

In summary, credit scoring systems evaluate an applicant's creditworthiness mechanically, based on key attributes of the applicant and aspects of the transaction, and determine whether an applicant is deemed creditworthy. Regulatory agencies evaluate these systems to ensure they are empirically derived and statistically sound and to examine the bank's policies on the use of the system, training of bank employees, and the number of high-side and low-side overrides.