What is loan scoring?
Loan ranking is a classification system that assigns a quality score to a loan based on the borrower’s credit history, the quality of collateral, and the likelihood of repayment of principal and interest. A score can also be applied to a loan portfolio.
How loan scoring works
Banks often develop their own rating scales with up to 12 categories ranging from “premium”, indicating little or no risk, to “lower” or “doubtful”, indicating a high probability that the loan will be bad – and “loss “. indicating little or no recovery is likely.
Bank examiners use a classification system when conducting a bank examination and will assign their own marks to a sample of the bank’s loan portfolio. In scoring a loan, the examiner will review the loan documentation, the guarantee, and the borrower’s financial statements.
Banks can develop their own loan rating scales with a dozen categories ranging from “prime”, where there is little or no risk, to “loss”, indicating that little or no recovery is likely.
A standardized loan classification system published by three federal supervisors in 1949 included three main categories for loans deemed weak:
- Substandard loans were those that posed a higher than normal risk due to the financial health or unfavorable track record of the borrower, inadequate collateral or other factors.
Impaired loans were those for which collection was impaired, but the loss was not determined.
- The loss related to loans considered to be uncollectible.