Free PDF Ebooks Files @AcrobatPlanet.Com

Since the advents of credit cards in the 1960s, lenders have used credit scoring, both application and behavioural scoring to monitor and control default risk. However in the last decade their objective has changed from minimising default rates to maximising profit. Lenders have recognized that operating decisions are crucial in determining how much profit is achieved from a card. This paper focuses on the most important decision in an operating policy: the management of credit limit. Soman and Cheema (2002) conducted a study on the use of credit limit policies in encouraging spending and found that the availability of additional credit does promote card usage in some consumers. Consumers assumed lenders have some sophisticated models, which was used to determine appropriate credit limits, but that is not the case in reality.

So how do lenders currently decide on what credit limit to offer a credit card customer? Most use subjective policies based on a risk/return matrix, i.e. they agree credit limits for each combination of risk band and average balance, which is considered a surrogate for the return to the lender from that customer. This approach is static in that it does not consider whether or how the customers default risk and profitability to the lender will change over time. Nor is there any model to guide what are the optimal credit limits to choose.