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What are the difference between Credit Scores and Credit Ratings?
in Mathematics by Diamond (55,528 points) | 26 views

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Credit Scoring

Credit scoring is a statistical method used to predict the probability that a loan applicant, existing borrower, or counterparty will default or become delinquent. It provides an estimate of the probability of default or delinquency, which is widely used for consumer lending, credit cards, and mortgage lending (Kenton 2019).

Credit scores provide an indication of creditworthiness. They are typically a numerical expression that indicates how likely a consumer or business is to make credit repayments regularly and in full, including any additional charges, such as interest and fees. Scores can be scaled to any numerical range; generally, the higher the credit score of the borrower, the lower the risk of nonpayment of credit. CSPs may use credit scoring in risk-based pricing in which the terms of a loan, including the interest rate offered to borrowers, are based on the credit risk of the borrower.

The main advantage of a credit score is that it is a quick, consistent and effective way for CSPs to be able to decide on an applicant’s eligibility for a loan or contractual payment scheme. It also impacts relative product pricing and profitability of the CSP.

Credit Ratings

The assessment of the creditworthiness of businesses, large corporations, and sovereign governments is generally done by a credit rating. Credit ratings may apply to companies, sovereigns, subsovereigns, and those entities’ securities, as well as asset-backed securities.

A good credit rating of a counterparty indicates a high possibility of repayment of debt obligations in full. A poor credit rating suggests that the counterparty has had trouble repaying debt obligations in the past and might face those challenges again in the future (Kagan 2019). Credit ratings typically apply to companies (usually larger corporations) and governments, whereas credit scores typically apply to individuals and to micro, small, and medium enterprises (MSMEs).

Credit ratings are assigned either by credit rating agencies or, internally, by CSPs. For instance, Standard & Poor’s has a credit rating scale ranging from AAA (excellent) to C and D (a rating below BBB- is considered a speculative grade, which means the counterparty is more likely to default on financial obligations).

Credit ratings are important because they determine a counterparty’s access to credit, shape the terms of conditions of credit facilities such as interest rates charged by CSPs, and influence potential investor decisions. Business credit scoring is largely used for business loans and trade credit assessment. 

by Diamond (55,528 points)

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