Credit Risk Modeling with Data Science


Financial institutions know there is always a fraction of risk when they agree to lend money to borrowers. They would naturally want to lessen this risk and lend cash only in cases where they know they would get their money back.

Credit scores and their history

The journey of credit scores began in 1936 with Ronald Fisher. He proposed a statistical method for performing discriminant analysis. The technique was used to distinguish between categories developed utilizing a list of quantifiable attributes. Durand discovered that he could also use this approach to identify which loans were good and which ones were bad in 1941.

This laid the foundation of credit scores. Financial institutions started allotting different credit scores to everyone applying for loans for varied purposes. The objective of these numerical scores is to inform the lending institutions of the likelihood of the borrower returning the loaned amount within the stipulated deadline.

With the help of credit scores, banks come up with risk-based pricing. This implies that if a client has a lesser credit score, he will be provided loans not on good terms and under stringent conditions and an excessive interest rate.

Data science and financial services

Data science has many applications in financial services. Banks need to comprehend the data in a better way and consequently perform feature engineering based on a baseline model. Based on the results of the feature engineering, developers can build a machine learning model that works on the credit scoring use case. Let us look at how data science can be instrumental in credit risk modeling.

Analyzing wider datasets

When one recognizes the latest risk drivers, they contribute to the growth of responsive and logical credit risk scoring. Data science can observe a lot of systems based on scorecards that humans are incapable of, which goes a long way in improving business sustainability.

These elements can be incorporated into a machine learning system so that the lending institution can get realistic and holistic evaluations of customer profiles. This system will be self-learning so that the client differentiation is intelligent and the credit risk calculation is more innovative.

With the help of feature engineering, present-day financial institutions have the power to develop a baseline model, which in turn, can boost credit scoring use cases.


Traditional models can give a headache to financial institutions since if you insert new parameters, they slow down and make the scoring procedure more complex. However, when it comes to machine learning algorithms, their nature is more dynamic and is self updated. They evolve with time abandoning outdated methods and inserting new enhancements without human interference.

One can build these algorithms by observing overfitting issues and utilizing cross-validation. Cross-validation also needs to be used later at the time of model selection.

If you are interested in the recalibration process, you need to get the hang of data science to understand the latest developments. Doing the best data science courses can help you get ahead of everyone else and gain knowledge related to the relevant subject.

Accurate predictions

Conventional scoring algorithms work linearly by analyzing the historical data and estimating the potential creditworthiness. On the other hand, self-learning machine learning systems utilize the present and past data to enhance their prediction capabilities.

Data science has a variety of advanced technical applications. Banks can use it efficiently by utilizing methodologies that stop overfitting and modify hyper-parameters. The algorithms are given a free hand for big data analysis. Doing this ensures that you can develop concrete connections between fragmented variables. Forming this connection can cause a significant increase in the forecasting potential of ML algorithms, along with improved analysis of unstructured data.

Validation datasets can be coupled with the ROC-AUC curve score to produce better results. Distinct approaches can be selected for a trial so that the overall scores are as accurate as possible.

Improving cost-effectiveness

Many believe that machine learning systems are very expensive to execute; however, the reality couldn’t be more different. These models have proved that their cost efficiency is worth more in the long run than other traditional tools.

After developing the ML systems, their use is limitless, and the stakeholders can enjoy their advantages as many times as they want. Almost all credit scoring services backed by scorecards have a per-user basis charge calculated.

However, machine learning models represent a completely personalized and constantly learning system, representing a system that can fulfill all customer profiling and credit scoring requirements.

For example, machine learning models can offer adaptable ML-backed credit scoring solutions that can offer precise, intelligent borrower positions and precise borrower eligibility predictions to reduce the number of loans that could go bad in the future. This is why the machine learning solution will prove to be a good return on investment if you opt for it.

Another cost-effective investment is Great Learning’s data science & machine learning PG course. During the entire course span, you will learn a lot about data science and machine learning, and this knowledge can help you excel further in your career.

Wrapping up

Data science solutions and machine learning algorithms offer a scalable method for credit risk scoring. Data engineers are a good addition to the team and can develop scalability to enhance the software’s capacity.

Data scientists can play around with the models to find the model that can enhance credit scores on the system for each user. Using a good data science solution, credit can be made available for many customers, and it can also lead to financial institutions discovering many prospective clients for offering them loans.

If you also wish to become a data scientist or data engineer, you can become one without hassle. Great Learning has excellent data science courses that help enhance your skillset and become employable.