How credit scores can improve risk assessment from Alicia Reno's blog

In the financial landscape of today, credit scores play a pivotal role in assessing the creditworthiness of individuals and businesses, especially during times when they seek to apply for gold loans or personal loans in Sri Lanka, or when businesses apply for facilities like pre-shipment finance, or business loans in Sri Lanka.

In Sri Lanka, where the financial sector is in a state of rapid evolution, the importance of accurate and comprehensive credit scoring systems cannot be overstated. By improving credit scores, financial institutions such as banks and other lending facilities, can enhance risk assessment, leading to better decision-making, reduced defaults, and increased financial inclusion.

Understanding credit scores

These scoring systems are numerical expressions based on analysing an individual or businesses’ credit files, representing their creditworthiness. These scores are used by lenders to gauge the potential risk posed by lending money to consumers and to mitigate losses due to bad debt. Higher scores indicate lower risk, while lower scores signify higher risk.

In Sri Lanka, however, the scoring system is still in its developing stage, with significant room for improvement to support the needs of the financial sector.

Current challenges in Sri Lanka

1.      Limited data: One of the biggest challenges in the country is the lack of comprehensive credit data. Since many individuals and small businesses operate outside the formal financial system, which results in incomplete histories. This limitation affects lenders negatively when trying to assess the creditworthiness of a borrower.

2.      Inconsistent reporting: Credit information reporting if often inconsistent, with gaps and inaccuracies in the data collected by credit bureaus. This leads to inaccurate scores, which affects both lenders and borrowers.

3.      Lack of awareness: The general lack of awareness among the public regarding the importance of maintaining a good score, and being unaware of how their financial behaviour affects their creditworthiness, leads to poor credit management practices.

4.      Technological barriers: The technological infrastructure required to support advanced credit scoring systems is still in its developmental stages. This includes the integration of big data analytics, machine learning, and artificial intelligence to create more accurate and predictive models.

Benefits of improved scores

1.      Enhanced risk assessment: Lenders get a more accurate assessment regarding the creditworthiness of individuals and businesses applying for loan facilities. This leads to better risk management, as lenders can make better informed decisions regarding loan approvals, interest rates and credit lines.

2.      Reduced defaults: With better risk assessment, financial institutions can reduce the number of defaults. By being able to accurately identify high risk borrowers, lenders can take preventive measures to safeguard against default, such as offering tailored financial products or requesting for additional collateral against the amounts borrowed.

3.      Increased financial inclusion: By providing accurate assessments, lenders can extend credit facilities to those who were previously excluded due to lack of credit history or poor scores, thereby bringing more individuals and businesses into the formal financial system.

4.      Lower interest rates: When lenders have confidence in the accuracy of credit scores, they are more likely to offer competitive interest rates, benefiting those borrowers who have good scores by being able to access facilities at lower rates.

5.      Economic growth: Improved access to facilities stimulates economic growth. SMEs are able to expand their operations with better financing options, leading to job creation and improved economic activity.

Steps that can be taken to improve credit scores in Sri Lanka

1.      Comprehensive data collection: In order to build accurate scores, it is essential to collect comprehensive data. Integrating data from various sources, including banks, other financial institutions, utility companies, and telecommunication providers can facilitate this. Expanding the data pool offers a more holistic view of an individual’s or businesses’ credit history.

2.      Enhancing reporting: Ensuring consistent and accurate reporting is crucial. Relevant bureaus must work closely with financial institutions to standardise reporting practices and minimise discrepancies. Information should be subject to regular audits and updates in order to improve its reliability.

3.      Public awareness campaign: Educating the public on the importance of maintaining a good credit history is vitally important. Financial literacy programmes can help individuals understand the impact of their financial behaviour on scores, encouraging responsible credit management.

4.      Leveraging technology: Investing in advanced technological solutions is the key to gaining these improvements. New innovations in technology can lead to more accurate risk assessment, and financial institutions should collaborate with technology providers to develop and implement these solutions.

5.      Regulatory support: The government and regulatory bodies play a crucial role in supporting the development of robust scoring systems. Implementing policies that promote data sharing, protect consumer rights, and encourage innovation create an enabling environment for improved assessments.

Improving scores is a crucial step towards enhancing risk assessment in Sri Lanka. By addressing current challenges, leveraging technology, and fostering public awareness, the country can create a more accurate and reliable scoring system that benefits both lenders and borrowers. This, in turn, will lead to better financial decision-making, reduced defaults, increased financial inclusion, and overall economic growth.

As Sri Lanka continues to evolve its financial sector, prioritising these standards will be instrumental in building a robust and inclusive financial ecosystem. Banks have the ability to assist both individual consumers and businesses can improve their financial situation for operations and growth, and contribute positively towards the growth of the economy.