Credit risk management: economic implications of goal setting

Abstract

The article examines the influence of the choice of the goal setting in credit risk management tasks on credit decision-making (determination of the cutoff point of the scoring model) and the performance indicators of the financial institution.

The purpose of the article is to develop a scientifically based approach to the improvement of credit risk management mechanisms in terms of credit decision making. This goal is relevant for financial institutions (banks and microfinance organizations) due to its decisive role for increasing the efficiency and profitability of lending activity.

The work utilizes a systematic approach to the analysis of credit risk management goals. A number of target indicators have been studied for which it is possible to set optimization tasks (according to the minimax subcriterion) and stabilization (the desired goal is to maintain the indicator at a given level or within a known limit), as well as to combine them into complex goals. The method of economic-mathematical modeling is applied to carry out calculations that illustrate the features, advantages and disadvantages of using different goals to determine the cut-off point of the scoring model. The graphic method is used for a visual representation of the obtained results and justification of the main statements of the work.

On the basis of the conducted research, three principles were formulated that can be relied upon when choosing the goal of credit risk management: the principle of adequacy, efficiency and consistency. It is proved that the goal of maximizing profit from lending activity differs significantly from other goals, satisfies the three stated principles and makes it possible to effectively reject loss-making credit applications while approving the profitable ones. A conclusion was made regarding fundamental nature of the goal-setting process and a choice was made in favor of a simple yet effective approach to credit risk management. In this case, other performance indicators of credit activity (level of approval and delinquency, profitability, etc.) are forming as a consequence of the practical use of the goal of profit maximization as a basic criterion for making credit decisions. This approach can justify an increase in the application approval rate and profit, even if it leads to an increase in overdue rates.