Credit analysis benefits of a probability of default analysis

Financial institutions may inject a probability of default (PD) analysis into several steps of their credit risk processes, and each use-case provides a different benefit to the bank that directly impacts its workflow efficiency, credit decision quality, and most likely profitability.

Before any financial statements have been spread, a PD analysis can be an effective way to perform pre-screens. Lenders, for example, can analyze a business in just a few minutes and quickly see if the loan could be worthwhile (yes) or one on which they should quickly pass (no). These pre-screens could reduce strain on the credit department.

It provides management with a tool with which they may perform a deeper and more objective analysis when making credit decisions. Banks or credit unions that may have previously had very small or nonexistent commercial and industrial (C&I) concentrations in their portfolio might be especially interested in tools that add depth and objectivity to the analysis performed on potential borrowers. Whether a banker is used to analyzing private companies or not, a PDM is an accurate and reliable addition to an existing credit analysis process.

Similarly, a financial institution can use a probability of default model to validate their risk rating process. For a loan that may be teetering between ratings, a calculated PD for a business could provide additional clarity as to its appropriate rating. In most cases, a probability of default is an excellent component to add to an existing risk rating scorecard or similar analysis.

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