The CARD Act has posed a number of challenges for issuers, not the least of which is how best to determine a consumer's “ability to pay”—a requirement that applies not only to new accounts, but also for credit line increases.
The predominant response from issuers has been to implement an income estimator tool or income estimation combined with some sort of debt-to-income ratio. With these in place to ensure compliance, many issuers will continue to make line management decisions based on the historical bias toward setting low limits on consumers with low incomes and high limits on consumers with high incomes.
The problem is that income is a poor indicator of ability to pay. It's a subject I've covered in a previous post, where I share research showing how FICO® Scores are much better than income at predicting credit repayment risk.
Our research shows that issuers can make even more precise credit decisions—including line increases—by using an additional type of analytic to predict credit capacity. This credit capacity analytic has shown to be more predictive than income.
One FICO study on pooled bankcard data compared the ability of the FICO® Credit Capacity Index™ (CCI) and income to differentiate risk for given FICO® 8 score ranges. Like a FICO® Score, FICO® CCI is based on bureau data, but it analyzes this data to find out something entirely different: What is the ability of consumers' to manage increments of new debt on top of what they already have?
As the chart below shows, FICO® CCI more effectively isolates the least risky (solid blue line) and riskiest (solid red line) subpopulations compared to the income estimator (dotted lines), which shows little variance in bad rate by FICO® score bands.
Another study specifically looked at how an analytic capacity measure can boost line increase strategies. We used the FICO® 8 Score to determine which accounts would receive a line increase, then used FICO® CCI for assigning the increase amount.
We were able to reduce losses by 6.8% while growing balances. The forecasted result was a risk-adjusted revenue (RAR) gain of $2-$3 per account, and a 100 basis-point improvement in profit. A further slight improvement was achieved by adding income to the decision matrix. (We break down the research specifics in our latest Insights white paper on the CARD Act.)
What do these research results boil down to for card issuers? If your goal is just to comply with ability to pay requirements, then integrating an estimation of income with a FICO® Score may be an adequate solution. But if your goal is to also make more profitable credit line increase decisions, you need additional analytic insight into a consumer's credit capacity.