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OCC BULLETIN 1997-24
To: Chief Executive Officers of all National Banks, Department and Division Heads, and All Examining Personnel

Description: Examination Guidance

Purpose

This banking bulletin is intended to inform national banks of the OCC's concerns about national banks' use of credit scoring models. If used properly, credit scoring models (also called score cards) can be effective portfolio and risk management tools.

Background

Credit scoring models were first developed more than 50 years ago. Their use has increased tremendously as a tool for underwriting and administering all forms of retail credit, including credit cards, direct and indirect installment loans, residential mortgages, home equity loans, and small business credit. Credit scoring models can offer a fast, cost-efficient way to make sound decisions based on bank or industry experience.

Different types of credit scoring models are used for various activities. Application scoring models apply the bank's definition of good and bad accounts to identify and rank applicants. Behavioral scoring models are used to manage accounts, including credit line increases and decreases, over limits, and renewals. Collection scoring models may help determine accounts that are more likely to be collectible, and profitability scoring models are used to identify the most profitable marketing segments. Fraud detection and bankruptcy scoring models help identify accounts with possible fraudulent activity or borrowers likely to go bankrupt.

Credit scoring models can assist bankers with credit decisions. As stated in the OCC's Credit Card Lending Handbook, credit scoring models can help manage loan portfolio activities. A copy of that handbook was distributed to each bank in October 1996.

Credit scoring models can be used effectively to:

Control risk selection.
Manage credit losses.
Evaluate new loan programs.

Improve loan approval processing time.
Ensure that existing credit criteria are sound and consistently applied.
Improve compliance with the Equal Credit Opportunity Act (Regulation B) and the Fair Housing Act, if applicable.
Improve profitability.

Bank Management Responsibilities

As with any models, bank management must ensure that credit scoring models are used appropriately. Bank management must:

Understand the credit scoring models thoroughly.
Use credit scoring models for their intended purpose.
Validate or revalidate the credit scoring models' performance regularly.
Review tracking reports, including the performance of overrides.
Take appropriate action when the credit scoring models' performance deteriorates, which could include: reviewing lending strategies to determine their effect on the credit scoring model; actively managing the credit scoring model cut off strategies; or developing a new credit scoring model.
Ensure the credit scoring model's compliance with fair lending regulations.

Concerns

Over the past several months, examiners have identified some bank practices that resulted in the improper use of credit scoring models. The OCC is providing information about these practices to help other banks avoid similar experiences. Some problems that examiners have seen include:

Bank staff inadequately trained to monitor effectively the credit scoring model's performance.
Deficient bank management information systems (MIS) that impede tracking, monitoring, validating the credit scoring model at development, and revalidating the model over time.
Improper application of credit scoring models on products, subset of the applicants, or in geographic areas for which they were not developed without verifying effectiveness. Inconsistent use of credit scoring models, including excessive overrides.
Use of credit scoring models that include characteristics that may be discriminatory, may possibly have a disparate impact on a prohibited basis, or raise other Equal Credit Opportunity Act (Regulation B) or Fair Housing Act concerns.

OCC Actions

OCC examiners, in discussions with bank management, should:

Determine if the bank is using credit scoring models.
Alert them to the concerns seen at some institutions.
Review the adequacy of the bank's policies and practices for using these tools.
Followup on any areas where improvements are needed.

Conclusion

National bank management should evaluate its current use of credit scoring models and ensure that it is taking appropriate action to mitigate potential risks.

The attached Appendix contains more detailed guidance on the safety and soundness and compliance issues seen by OCC examiners in some institutions. Please refer bank staff responsible for credit scoring models to this information.

Originating Office

For further information, contact Credit & Market Risk (202) 649-6670.

Emory Wayne Rushton
Senior Deputy Comptroller for Bank Supervision Policy

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