On the use (and misuse) of Gini Coefficients in Credit Scoring
Over years of blogging, one of our most popular ever blog posts was about the Gini coefficient. In this series of posts, we revisit the Gini and dig further into its uses and the ways we see it misused in credit scoring.
What is a GINI?
For lenders around the world, the “Gini Coefficient” is an often heard, sometimes feared, and frequently misunderstood statistical measure. Commonly used to assess things like wealth inequality, Gini Coefficients are also used to evaluate the predictive power of credit scoring models. In other words, a Gini Coefficient can help measure how good a credit score is at predicting who will repay and who will default on a loan: the better a credit score, the better it should be at giving lower scores to riskier applicants, and higher scores to safer applicants.
Though calculating a Gini Coefficient is complex, understanding it is fairly simple:
A Gini Coefficient is merely a scale of predictive power from 0 to 1, and a higher Gini means more predictive power.
On the use (and misuse) of Gini Coefficients in Credit Scoring: Comparing Ginis
This is part 2 of a series of blog posts about Ginis in Credit Scoring. To see the part 1, follow this link.
What is an AUC?
AUC stands for “Area Under the (ROC) Curve”. From a statistical perspective, it measures the probability that a good client chosen randomly has a score higher than a bad client chosen randomly. In that sense, AUC is a statistical measure widely used in many industries and fields across academia to compare the predictive power of two or more different statistical classification models over the exact same data sample [1].
How is AUC used in Credit Scoring?
In the particular case of Credit Scoring, AUCs are useful for example in the model development process, when there are several candidate models built over the same training data and they need to be compared. Another typical use is at the time of introducing a new credit score, to compare a challenger against an incumbent score over the same sample of data under a champion challenger framework.
On the use (and misuse) of Gini Coefficients in Credit Scoring: Gini and Acceptance Rate
The relationship between Gini Coefficients and Acceptance Rate
One of the most frequent uses of Credit Scores is to decide whether to admit or reject an applicant applying for loan. This is usually called an “Admission score” or “Origination score”. A key decision around this use case is the selection of a score cut-off that will determine a threshold for admission. This cut-off value determines the acceptance rate of the population.
If the score is working well and predictive power is good, the relationship between acceptance rate and default rate will be positive. The higher the acceptance rate, the higher the default rate of the accepted population and vice versa. The direction of this relationship also has two implications: when acceptance rate is higher, the absolute number of bad loans (i.e. non-performing loans) or “bads” will also be higher, and the proportion of these “bads” in respect to the total loans in the accepted population will be higher too.
What does this mean in practical terms?
It means that the predictive power as measured by a Gini coefficient for the exact same score at different levels of acceptance rate for the exact same population will be different. The higher the acceptance rate, the higher the Gini coefficient and vice versa.
On the use (and misuse) of Gini Coefficients in Credit Scoring: the Economics of Credit Scoring
Gini Coefficients and the Economics of Credit Scoring
On a global scale, billions of dollars in debt are granted every year using decisions derived from credit scoring systems. Financial institutions critically depend on these quantitative decision to enable accurate risk assessments for their lending business. In this sense, as with any tool that serves a business purpose, the application of credit scoring is not ultimately measured by its statistical properties, but by its impact in business results: how much can Credit Scoring help to increase the benefit and/or to decrease the cost of the lending business.