International Journal of Business and Social Science Vol. 3 No.

17; September 2012

Design and Development of Credit Scoring Model for the Commercial banks of
Pakistan: Forecasting Creditworthiness of Individual Borrowers

Asia Samreen
MBIT. Student
IBIT, University of the Punjab
Lahore, Pakistan

Farheen Batul Zaidi

Lecturer
IBIT, University of the Punjab
Lahore, Pakistan

Abstract
This research study summarizes the loan evaluation method known as credit scoring.Credit scoring is a technique
that helps banks decides whether to grant credit to applicants who apply to them or not.The main objective of the
research was to evaluate credit risk in commercial banks of Pakistan using credit scoring models.The
requirement of credit scoring models by commercial banks of Pakistan to assess the creditworthiness of
individuals was described. A credit scoring modelwas developed called as Credit Scoring Model for Individuals
(CSMI), which can be used by commercial banks to determine the creditworthiness of individual borrowers
requesting for personal loans. The CSMI was explained along with a detailed look at different credit scoring
models. The results of the developed credit scoring model were compared with the other statistical credit scoring
techniques known as logistics regression and discriminant analysis. Type I and type II errors had been calculated
for all the credit scoring models used. The results shows that the proposed model “CSMI”has more accuracy rate
with no errors as compared to LR and DA.Also, several suggestions for further research were presented.

Keywords: Credit Scoring;Credit Risk; Personal Loans; Creditworthiness; Discriminant Analysis; Commercial
Banks

1. Introduction
The motivation for this research is to explore insights into the level of loan delinquency and creditworthiness
among the individualborrowers and the lending practice of banks to ultimately reduce the number of non-
performing loans of commercial banks of Pakistan.
This study is mainly done to build a model for commercial banks with various exhaustive list parameters among
different degrees of importance. The proposed credit scoring models will facilitate the banks to check the
creditworthiness of the individuals. The proposed credit scoring model will decide among the good and bad loan
applications. Credit scoring models assess the risk of a borrower by using the generated credit score that will be
made by extracting data from loan applications, socio-demographic variables and credit bureau reports.
Dimitriu, Avramescu and Caracota (2010) defined that lending money is risky, but at the same time profitable.
Interest and fees on loans are source of profits for the banks. Banks do not want to grant credit to those borrowers
who are not able to repay the loan. Over time, some of the loans can become bad even if the banks do not want to
have bad loans.
Historically, credit risk caused heavy losses to commercial banks functioning in Pakistan. The senior management
of banks required to design policies, methods, and procedures to measure, monitor and control credit risk.
(Kanwar, 2005).
During 2008, the growth rate of non-performing loans (NPL) in Pakistan had risen at a shocking rate of 65%, but
the growth rate reduced to 20% in 2009. Consumers are the common defaulters. (Aazim, 2010)
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By analyzing the written off loans of commercial banks in Pakistan, this will assist in taking effectual measures to
enhance the quality of credit approval process and ultimately reduce the losses of banks from bad debts. Many
written off loans have been caused by the improper management of the loan applications starting from
disregarding the accepted rules of loaning. This want to be observed cautiously and banks should take effective
measures to minimize bad debts or written off loans in the future.
The commercial banks of Pakistan have to find a remedy to reduce their non-performing loans, since the
slowdown in the economy; one mostly implemented system for solving this problem is “Credit Scoring.”
1.1 Objectives
The objectives of this study are as follows:
• To design a credit scoring model for individuals to assess their creditworthiness
• The validity of the proposed credit scoring model would be compared with the preexisting statistical
credit scoring models.
1.2 Rationale of Study
Before offering credit to individuals, their financial position should be examined as offering loan is very risky. On
the basis of the financial position of their applicants requesting credit, banks assign credit scoring and on the basis
of credit scores the bank decides whether to offer the credit to these applicants and also decides the credit limits.
Our research aimed to evaluate the creditworthiness of individuals by calculating the credit scores via credit
scoring models.
2. Research Questions
The questions of the research study are as follows:
• What is the creditworthiness of individual borrowers requesting banks for loan?
• What is the risk category of individual borrowers?

3. Review of Literature
Thomas, Edelman and Crook (2002) described “Credit Scoring is the set of decision models and their underlying
techniques that aid lenders in the granting of consumer credit. These techniques decide who will get credit, how
much credit they should get, and what operational strategies will enhance the profitability of the borrower to the
lenders.”
A creditor can make revenues when they successfully predict the creditworthiness and default risk of applicants
depending on the default predictor factors. Credit scoring is a proper technique that connects these factors to the
probability of default. (Lieli & White, 2010)
While the concept of credit is 5000 years old, the credit scoring is only 50 years old. Credit scoring is basically an
approach to classify distinctive groups when the lender cannot consider all the characteristics that describes the
groups but just describes those that are closely related. Fisher (1936) as cited in (Thomas, Edelman, & Crook,
2002) initiated to solve this problem of identifying distinctive classes in a total population. Further, it was
concluded that good and bad creditors could be classified by using the single method, as described by Durand
(1941).
According to new Basel II Capital Accord, default is defined as 90 days delinquent this is defined by Siddiqui
(2006). Kanwar (2005) defined credit risk as risk arises when the borrower either is unwilling to repay the loan or
he is not able to repay the loan granted which results in economic loss to the bank.
Credit scoring has used the data on consumer behavior for the first time so it can be declared as the grandfather of
data mining. Firstly, a lender should take two decisions in the credit approval process; one is whether to give loan
to a fresh borrower; the technique that used to make this judgment is credit scoring and, other, whether to increase
the credit limits of the existing debtors; the techniques that assist the second decision are called behavioral
scoring. (Thomas, Edelman, & Crook, 2002) Lenders in developed countries analyze the creditworthiness of
borrowers based on their credit histories taken from credit bureau and also check borrower’s salary and
experience before loan approval. (Schreiner, 2000)

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According to Thomas, Edelman and Crook (2002) lending institutions started adopting the credit scoring models
in evaluating personal loans, after few years for the evaluation of mortgage and small business loans in 1980, after
analyzing the effectiveness and accuracy of credit scoring models in the evaluation of credit cards.
Classification models in credit scoring analyze the characteristics of applicants such as age, income, marital
status, payment history are used to classify new candidates into good or bad (Chen and Huang, 2003). Many
banks use only two groups as “good” or “bad” applicants and many use three groups “good”, “bad” or “refused”.
The credit managers analyze the refused applications once again. (Abdou, Masry, & Pointon, 2007)
According to Chijoriga (2011), Credit scoring models can be qualitative as well as quantitative in nature.
Qualitative technique is judgmental and subjective; the disadvantage of qualitative method is that there is no
objective base for deciding the default risk of an applicant. While, quantitative technique is a systematic method
to categorize into performing or non- performing loans and it has removed the shortcomings of qualitative
technique and proved to be more reliable & accurate model.
Both the lenders and the borrowers could bear the costs of loan delinquencies. The creditor will not get the
interest payments and also the loan given. The debtor will come in the list of defaulters so his character will be
affected as well as he cannot further take loans from the same creditor and also could not invest that loan taken.
(Baku & Smith, 1998)
Lieli and White (2010) analyzed that credit is granted to applicants after assessing their creditworthiness, when an
applicant meeting the cut off score the he/she will be a accepted and considered as good applicant and increase
their credit limits while all those applicants having credit score with total scores lower than cut off score is
rejected.
Sullivan (1981) defined that the credit scoring technique work on the addition or subtraction of credit score based
on number of factors such as time on a current job, education level of an individual applicant. On the basis of this
statistically derived cut off score compared to generated credit score of an applicant, the loan application is
accepted or rejected.
Sullivan (1981) pointed out that the credit scoring models have biasedness as it discriminates the females with
males in granting loans. Despite the criticism, credit scoring models can be considered as very effective tools in
the area of Finance and Business. It is prohibited to include variable of race and religion in the default prediction
factors but that does not stop some authors.(Thomas L. C., 2000)
Steenackers&Goovaerts (1989) describes the most fundamental application of credit scoring models is the
evaluation of new individual loans. According to Orgler (1971), there are many research studies done on granting
loans to current individual but less literature is present on loans given to fresh individual.
According to Basel II rules, banks should have a sound internal rating system to assess the credit risk of debtors
through which bank loan officers can effectively and accurately quantify risk and define credit limits
accordingly(Hasan & Zazzara, 2006). Lopez and Saidenberg (2000) defined that according to Basel Capital
Accord; banks must keep 8% capital against the risk-weighted assets.
Barefoot (1996) described several key benefits of credit scoring: credit scoring lowers the cost of lending as it has
reduced the part of human in evaluating a loan application. Credit scoring models has increased the accuracy of
predicting the actual credit risk of debtor. According toPonicki (1996), for banks credit scoring provided a
standard technique of loan evaluation across the entire bank, efficient way of executing the transactions and also
enhances the collection of loan. Credit scoring models provide benefits to customers by offering simple
application process, results of credit approval in a timely manner, access to credit when they need it.
Lending institutions adopt seventy percent of credit scoring models to evaluate microcredit and 97% to assess the
credit card requests.(Mester, 1997)
Credit scoring models rely on the credit history of those debtors who are accepted by the banks. Overlooking the
rejected applicants affects forecast accuracy of credit scores and has some effect on their discriminatory
power(Barakova, Glennon, & Palvia, 2011).

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There are numerous commercially available decision support systems for credit scoring of any type of corporation
but they suggested that there should be minimum one standard system of credit scoring that can be used by
commercial banks worldwide.(Emel, Oral, Reisman, & Yolalan, 2003)
According to Schreiner (2002), statistical scoring cannot replace the loan officers because ultimately it is the duty
of the credit analysts to make the credit decision and these scoring techniques can act as a help guide. Statistical
scoring reminds the credit manager the elements of risks that they have ignored.
4. Theoretical Framework
4.1 Dependent Variable
In this research study the ‘Credit Score’ is the independent variable.Credit score is a number that denotes the
creditworthiness of applicants. The higher the credit score, the higher the creditworthiness of an applicant, while
the lower the credit score, the lower the creditworthiness of an applicant.
4.2 Independent Variables of CSMI
There were total sixteen independent variables for the credit scoring model for individuals. Most of these factors
are socio- demographic variables.

1 Gender 9 Occupation
2 Client's locative situation 10 Working period with the last employer
3 Education level 11 Working period with the current employer
4 Proximity towards bank X branches 12 Loan period
5 Marital status 13 Banking references at Bank X
6 Age 14 Monthly net income of the applicant
7 Number of dependents 15 Credit History
8 Loan tenure 16 Loan from other banks

5. Research Methodology
The primary data was collected by personal interviews with the credit managers and by administering a
questionnaire. Personal interview method is used for the analysis of credit approval process by the banks. Here,
personal interviews will be conducted with the credit managers of different commercial banks. A questionnaire
was distributed to the credit departments of commercial banks to collect data about customer’s personal loans.
The sensitivity of the topic turned out to be a bigger constraint, restricting the research sample to be 250. These
250 customers are those who have applied for the grant of credit and were accepted by the bank. The individuals
data was collected from the well reputed commercial banks of Pakistan namely, Standard Chartered Bank and
Askari Bank from different branches of Lahore and Islamabad.
5.1 Data Analysis Tools
Financial tools that were used to calculate the creditworthiness of individuals which includes Descriptive
Statistics (Frequency Distribution &Cross Tabulation), the Discriminant Analysis (DA), Logistic Regression
analysis on SPSS 17.0.
5.2 Developing Credit Scoring Model
The main objective of the research is the design & development of a new and potentially more effective credit
scoring model defined as the Credit Scoring Model for Individuals (“CSMI”). The 1st step in developing the
credit scoring models was finding the different components affecting the creditworthiness of applicants. For
identifying these factors many articles and websites related to consumer loans were studied.

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5.2.1 Credit Scoring Process

Individual Borrower

Factors considered in Scoring

Gender
Client's locative situation
Education level
Proximity towards bank X branches
Marital status
Age
No. of dependents
Loan tenure
Occupation
Working period with the last employer
Working period with the current employer
Loan period
Banking references at Bank X
Monthly net income of the applicant
Credit History
Loan from other banks

Reach Cut No
off Score Reject Loan

Yes

Accept Loan

5.2.2 Credit Scoring Model for Individuals

FACTORS Score
Gender
o Male 1
o Female 0
Client's locative situation
o Own house 3
o Personal apartment 2
o Parents apartment 1
o Rent 0
Education level
o PhD. 4
o Master / M-Phil 3
o Graduate 2
o Inter / Matriculation 1
o < Matriculation 0
Proximity towards bank X branches
o Bank X branch exists in the residence place of the applicant 2
o Bank X branch does not exist in the residence place of the applicant 0
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Marital status
o Married 3
o Single / Widow / Divorced 1
Age
o Between 20 and 30 years 4
o Between 30 and 40 years 3
o Between 40 and 50 years 2
o Between 50 and 60 years 1
o Above 60 0
No. of dependents
o 0 person 3
o 1 person 2
o 2 persons 1
o 3 or more persons 0
Loan tenure
o 1 year 4
o 2 Years 3
o 3 Years 2
o 4 Years 1
o 5 years 0
Occupation
o Salaried employee 3
o Businessman 2
o Student 1
o Unemployed 0
Working period with the last employer
o Greater than 5 years 4
o Between 2 and 5 years 3
o Between 1 and 2 years 2
o Retired 1
o NA 0
Working period with the current employer
o Greater than 5 years 4
o Between 2 and 5 years 3
o Between 1 and 2 years 2
o Retired 1
o NA 0
Loan period
o Shorter than the remaining period till pension 2
o Higher than the remaining period till pension 0
Banking references at Bank X
o Deposit and loan 3
o Loan / credit card 2
o Deposit / credit card 1
o None 0
Monthly net income of the applicant
o Above 100,000 4
o Between 55,000 and 100,000 3
o Between 40,000 and 55,000 2
o Between 25,000 and 40,000 1
o Between 10,000 and 25,000 0
Credit History
o 90 days default 1
o 60 days default 2
o 30 days default 3
o None 4
Loan from other banks
o Yes 0
o No 1

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The socio-demographic factors were used to measure creditworthiness of individual applicants. Each of factors
used in SCMI has several attributes with certain scores. There are total 16 variables included in the construction
of the credit scoring for individuals.
The range of credit scores is from 2-49. The maximum credit score that an individual can have is 49 and lowest
credit score is 2. Individuals with lower credit scores have more default risk & lower creditworthiness as
compared to individuals with high credit score, who have low risk & they are considered to be more creditworthy.
Credit Score % Credit Score Range Quality Risk Class
91% -100% 44 - 49 Highest A
76%- 90% 37 – 43 Good B
50% – 75% 25 - 36 Average C
Below 50 % < 25 Below Average D

When an applicant’s credit score lies in the range of 44-49, it means he/she will lie in the risk class A that is
showing lowest possible risk and bank considered the applicant of highest quality. We have taken 90 to 100 %
(top 10%) of the maximum score of 49. The second risk class is B having good quality of loan applications; the
credit score of this category is between 37 to 43. All applicants having credit score greater than & equal to 25 but
less than & equal to 36 will lie the risk class C, having an average quality of loan application.
The cut off score of this model is 25, which is 50% of the total credit score of 49. Applicants having total credit
score less than 25 will not be qualified for loan, hence rejected.
The lowest possible credit score an individual can have is the cut off score..Any applicant having credit score
below 25, will be rejected and any applicant having credit score above 25 will be accepted and loan granted to
that applicant. Below cut off score the risk is very high to accept an applicant’s loan application and above cut off
score there is relatively low depending upon their risk class.Risk class ‘A’ shows no default risk due to highest
credit score. Risk class ‘B’ shows lowest default risk because of high credit score. Risk class ‘C’ represents
medium level of default/ credit risk as having average level of credit score. Risk class ‘D’ indicates the high level
of risk and also having below average credit score.
6. Data Analysis
In the questionnaire of credit scoring model for individuals, a data set of 250 applicants was collected; out of
which there were 158 males comprises of 63.2% of the total population and only 92 females which made 36.8%
of the total population.
It is concluded that there were 17.2 % defaulter female borrowers as compared to 21.2% of defaulter male
borrowers, so females have less probability of default as compared to males. There were 19.6% of non-defaulter
female borrowers as compared to 42% of non-defaulters male borrowers, so it is concluded that males were more
creditworthy, have less probability of default because they were more financially strong in Pakistan as compared
to female borrowers.
Results shows that all those individuals who have their own house have high creditworthiness and less probability
of default. All the sampled applicants have education level less than matriculation were forecasted to be defaulters
or bad applicants.Among the good applicants or non-defaulters there were 0% applicants who have education
level less than intermediate and 16 applicants consists of 84.2% of the total population of PhD’s within education
level. So it is concluded that as the education level increases the creditworthiness also increases and probability of
default decreases and vice versa.
6.1.1 Credit Scoring Models
For the purpose of determining creditworthiness of individuals we have used several credit scoring techniques
such as credit scoring model for individuals, logistic regression (LR) and discriminant analysis (DA). We have
used the LR and DA to compare the accuracy of the developed credit scoring model. We have discussed the
results of each credit scoring model and also compared their results.

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6.1.1.1 Credit Scoring Model for Individuals (SCMI)

We have developed a new credit scoring model named as “Credit Scoring Model For Individuals (CSMI)” which
has considered all the important factors such as socio demographic variables, credit history, loan tenure, age,
occupation etc.
Classification results using Credit Scoring Model for Individuals (CSMI) a
Predicted group
Credit Score
Observed group 0 Bad 1 Good Percentage
Credit Score 0 Bad 96 0 100.0
1 Good 0 154 100.0
Overall Percentage 100.0
a. Cut-off point 0.50

After adding the credit score of all sixteen predictors on a 3, 2 & 1 basis we developed a total credit score. This
total credit score of an individual was compared with a cut off score which is 50%. The resulting decision was
accept and grant loan when the credit score was above the cut off score and rejected when falls below loan. All
the applicants who lied at the cut off score exactly are accepted but designated for further analysis by credit
analysis.
The classification results using Credit scoring model for Individuals are that out of 250 applicants, there are 96
applicants comprising of 38.4% of the total population who are predicted to be bad or defaulters and these
defaulter applicants have credit score below the cut off score.
There are 154 applicants consists of 61.6% of the total population, who have credit score above the cut off score,
so they are predicted to be good customers showing good creditworthiness and less probability of default. The
overall accuracy of this model is 100%. There are 0 applicants considered bad as a good and there are also 0
applicants considered good as a bad. So there is no misclassification cost as there is no Type I and Type errors.
6.1.1.2 Logistic Regression
As we can see from Table 59 and Table 65, all the variables are significant except the credit history of 30 days
and loan from other banks at 0.01. According to commercial banks in Pakistan 30 days default is not considered
as a default, hence applicant is acceptable at 30 days default, so that is why it is not significant at 0.01. The
overall model is significant as the p-value is 0.000 ,which is less than 0.01 as shown in Table 60. The
classification results generated by using logistic regression credit scoring model (LR) using the sixteen factors are
as follows:
Classification Results of LRa
Predicted
Credit_Score
Observed Bad Good Percentage Correct
Step 0 Credit_Score Bad 95 1 99.0
Good 2 152 98.7
Total Percentage 98.8
a. The cut value is .500
The results from the classification of LR shows that there are 95 applicants predicted to be bad or defaulters,
comprising of 38% of the total population and there are 152 applicants (60.8%) out of 250 applicants who are
above the cut point 0.5 and acceptable for the grant of loan, hence they are good applicants.
The correct classification rate was 98.8% of LR having cut value equal to 0.5, as the P-value of LR shown to be
lower than 0.01 so it resulted that default predictors are significantly related at the 95% confidence level.
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There are two types of error which must be mentioned are Type I and Type II error. Type I error is predicting a
bad credit application as a good credit application while Type II error is predicting a good credit application as a
bad credit application. According to our results, there is 1.3% Type I error and the Type II error is 1.04%.
According to Table 64 at Step 9, the coefficients of the logistic equation are given and on that basis the logistic
regression is as follows:
Z =-30.304 + 3.257 Client’s_locative_situation + 5.233 Education_level + 4.462
Proximity_towards_BankX_Branches + 3.059 Marital_Status - 48.2 Occupation + 2.301
Working_period_with_the_last_employer + 4.370 Loan_period +4.496 Banking_references_at_BankX - 23.721
Credit_History (1)

6.1.1.3 Discriminant Analysis

Discriminant analysis was used as a credit scoring model to calculate the credit score that is the dependent
variable based on sixteen independent variables.

Classification Results of DAb,c,d

Predicted Group Membership
Credit_Score Bad Good Total
Original Count Bad 93 3 96
Good 4 150 154
% Bad 96.9 3.1 100
Good 2.6 97.4 100
a
Cross-validated Count Bad 91 5 96
Good 7 147 154
% Bad 94.8 5.2 100
Good 4.5 95.5 100
a. Cross validation is done only for those cases in the analysis. In cross validation, each case is classified
by the functions derived from all cases other than that case.
b. 97.2% of original grouped cases correctly classified.
c. 95.2% of cross-validated grouped cases correctly classified.
d. Cut off value is .500

The result from the classification of DA shows that there are originally 93 applicants (96.9%) predicted to be bad
and 150 applicants (97.4%) as good applicants. It can be observed that Type I error rate is 2.6% and Type II error
is 3.1%. So Type II error is greater than Type I error, which does not cause any trouble because good applicant is
considered as bad and this cannot be so costly. There is 97.2% of accuracy that the original group cases correctly
classified.
After cross validating the results of DA, there are 91 applicants (94.8%) predicted to be bad and 147 applicants
(95.5%) as good applicants. It can be observed from the cross-validated classification results that Type I error rate
is 4.5% and Type II error is 5.2%.
The correct classification rate was 95.2% of DA after cross-validated having cut value equal to 0.500, as the P-
value of DA shown to be lower than 0.01, so it resulted that default predictors are significantly related at the 95%
confidence level. The overall model is also significant as the p-value is less than 0.01.
Eq. (2) represents the resulting standardized canonical discriminant function as seen from Table 71:
Z=0.081Gender + 0.305Client's_locative_situation + 0.089Education_level + 0.214
Proximity_towards_BankX_Branches + 0.271Marital_Status - 0.017Age +0.422No._of_dependents
+0.040Loan_tenure+0.466Occupation+0.218Working_period_with_the_last_employer+0.261Working_period_w
ith_the_current_employer+0.224Loan_period+0.260Banking_references_at_BankX+
.173Monthly_Net_Income_of_the_applicant +0 .671Credit_History +0 .024Loan_from_other_banks (2)
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6.1.1.4 Comparing Credit Scoring Models For Individuals

The accuracy rate is vital in comparing the classification accuracy of all the credit scoring models used in this
research study. We have compared the accuracy rates of all the models so that these models like LR and DA
would support the proposed credit scoring model for individuals. The credit scoring results along with the
accuracy rates of SCMI, LR and DA are as follows:
Credit Scoring Model Credit Scoring results
Bad-Bad Good-Good Accuracy rate*
(0-0) (1-1)
SCMI 100% (96/96) 100% (154/154) 100%
LR 99% (95/96) 98.7% (152/154) 98.8%
DA 94.8% (91/96) 95.5% (147/154) 95.2%
* cut off point is 0.5
The accuracy rate of SCMI is 100%, accurately classified the bad and good customers and logistic regression
(LR) has the accuracy rate of 98.8%, with 99% accurately classified the bad applicants and 98.7% accurately
predicted the good customers. The discriminant analysis credit scoring model has the accuracy rate of 95.2%, with
94.8% accurately classified the bad applicants and 95.5% accurately predicted the good applicants.
Hence it is concluded from the credit scoring results that the proposed CSMI have the highest accuracy rate and
also the most effective model as compared to other two credit scoring model of logistic regression (LR) and
discriminant analysis (DA). The accuracy rate of CSMI > LR > DA.
Comparing Errors
Credit Scoring Model Error results
Type I Type II
SCMI 0% (0/154) 0% (0/96)
LR 1.3% (2/154) 1.04% (1/96)
DA 4.5% (7/154) 5.2% (5/96)

Discriminant analysis has the highest Type I as well as Type II error as compared to SCMI and LR. As there is no
Type I & Type II errors in SCMI so there will be no misclassification cost. The Misclassification cost of DA
would be higher as compared to other two credit scoring models.
7. Discussion
The proposed model of credit scoring was developed keeping in view the increasing trend of NPLs as can be seen
in Figure 82 and this models was created only for individual borrowers as they are contributing to a large extent in
non-performing loans of the banks presented in Figure 81.
The accuracy rate of Credit Scoring Model for Individuals was 100%, more than the other models used. Among
the individual applicants the accuracy rate of LR (98.8%) is more as compared to DA, which is 95.2%.
There is no Type I error as well as Type II error in CSMI. The Type I error of CSMI is 0% and mostly banks
require that assessment tool which give less misclassification cost. Type I as compare to Type II error costs more
to banks as in Type I error bad applicants are considered as good which is highly risky. In Type II error the banks
just loose the potential applicants hence reduce their revenues. The credit scoring model which has the highest
accuracy rate and lowest error rates are considered to be the most effective, accurate, efficient and useful model.
Classification models in credit scoring analyze the characteristics of applicants such as age, income, marital
status, payment history are used to classify new candidates into good or bad (Chen and Huang, 2003)
The results from credit scoring model for individuals proved that the marital status is a strong predictor of credit
risk. We can estimate that married applicants are considered by banks to be less risky and more creditworthy
because they have responsibility of their spouses and families as compared to single applicants. Another factor
which may makes the married applicants more creditworthy is dual income.
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Education is an essential factor in assessing creditworthiness, according to CSMI it is concluded that all those
applicants who have higher level of education can default less and usually repay the loan taken on time. Because
when applicants have a higher education he/she would easily get a better job. Applicants who have lower level of
education would become difficult for them to find a better job, hence not showing a strong financial health.
Kocenda and Vojtek (2009) considered education as a fundamental component of credit scoring. He said that
debtors having high level of education are can default less as compared to debtors with low level of education.
It is proved from results that as the age increases the creditworthiness decreases because younger applicants have
less responsibilities and less number of dependents as compared to all those applicants who are elder. Hence,
lower age groups are more creditworthy as compare to high age groups. Loan tenure was also an essential factor
and shows considerable results, as the tenure of loan increase the credit risk increases. So, short term loans are
less risky and long term loans are more risky.
Occupation was also an essential factor is determining the creditworthiness of individuals. Hence, it is concluded
that salaried employees have less credit risk and more creditworthiness as compared to businessmen and students.
All the unemployed applicants are not considered to be creditworthy as they are not financially strong, having no
source of income to repay the loan.
The most important factor that must be considered is the credit history of the applicants. It can see from our
results as well as from past literature that those borrowers who have defaulted previously can be predicted to
default in the future.

8. Conclusion
This research study shows an evaluation of creditworthiness of individuals having personal loans to improve the
credit approval process and to decrease the non-performing loans in the commercial banks of Pakistan.In this
research study we have taken a sample set of 250 individual borrowers who have taken personal loans from the
various commercial banks of Pakistan, out of which 144 applicants who have clear history having no default ever,
there were 51 applicants who have default up to 30 days, 37 applicants have 90 days default.
The results using Credit scoring model for Individuals (SCMI) are that out of 250 applicants, there are 96
applicants who are predicted to be bad or defaulters. All these defaulter applicants have credit score below the cut
off score. There are 154 applicants are predicted to be good customers. The Credit Scoring Model for Individuals
(CSMI) assessed the creditworthiness of individual borrowers with 100% accuracy rate and distinguished the high
risk loan applications to low risk prior to default.
We have used logistic regression and discriminant to support the results of developed credit scoring model. The
accuracy rate of Credit Scoring Model for Individuals was 100%, logistic regression (LR) has the accuracy rate of
98.8% and the discriminant analysis credit scoring model for individuals has the accuracy rate of 95.2%. It shows
that proposed CSMI have the highest accuracy rate and also the most effective model as compared to other two
credit scoring model of logistic regression and discriminant analysis.
9. Recommendations
It is highly recommended that commercial banks should use this proposed credit scoring model as a part of their
evaluation process. By adopting this model banks can reduce their non performing loans. CSMI have included all
the factors that banks consider but in a systematic way.
It is recommended that future research studies should use the advanced credit scoring techniques like genetic
algorithms, fuzzy discriminant analysis and neural networks.For the generalization and accuracy of the results
generated by the credit scoring models, it is recommended to have a large data of individual borrowers. New
variables can also search which will help predicting the probability of default of individuals and corporations.In
our current research study we have used the accepted applicants in our sample; it is highly advisable to collect the
data of rejected applicants by banks, so that more versatile results could be obtained.

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