The impact of introducing economic variables into credit scorecards : an example from invoice discounting

Abstract: The paper shows how introducing economic variables into a credit scorecard improves the predictive power of the scorecard. Such a scorecard can forecast default rates accurately even when economic conditions change This means one can develop a single step approach to estimating the Point in Time PDs which are requirements of the Basel Accord banking regulations. A one step approach has several advantages when compared with the more standard approach of estimating scores with no economic variables first and then segmenting the portfolio by score bands and estimating the PD per segment. To build such a scorecard we decompose it into the population odds and the weights of evidence and shows that economic variables model the dynamics of the population odds part of the scorecard and so leads to this improvement in prediction.