A PRACTICAL APPROACH TO VALIDATION OF CREDIT SCORING MODELS
A PRACTICAL APPROACH TO VALIDATION OF CREDIT SCORING MODELS

Summary/Abstract: Introduction. The implementation of the Third Basel Accord raises many technical and methodological issues regarding the development and validation of credit risk models and makes these issues much more important. Bank regulators will pay more and more attention to testing model validation processes in order to examine the predictive accuracy of banks’ credit scoring models. Lenders therefore need to develop and apply the approaches for operational monitoring of predictive accuracy and modifying the cutoff value as one of the most important parameters of credit scoring models. The author poses the receiver operating characteristic (ROC) curve technique that can be successfully used to validate credit scoring models. The purpose of the research is testing the application of ROC curve technique for estimating the validity and predictive accuracy of credit scoring models. Results. The main parameters of credit scoring models validation were summarized. The possible criteria for determining the acceptable cutoff value for credit scoring models are presented. The approbation of the ROC curve technique is given by comparing two logistic models developed on the factual statistical data. Conclusions. The ROC curve technique can be applied successfully to estimate validity and compare credit risk models. The research gives recommendations of how to apply the proposed technique in the validation process. The area for the further research can be the consideration of the ROC curve technique in terms of the economic benefits and losses from the true and false classified credit applications.

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