Let me suggest what I think is happening in terms of the apparent contradiction in lenders being both too tight and at the same time offering too much money. The credit industry has gotten very good at classifying you into a risk category to determine chances that they will have to write off the money lent into that category.I should add that in Canada there is the additional issue that credit card companies now need permission from the card holder to extend the card holder's credit limit. This means that risk to exposure formulas will need to be modified as new data comes in on how accepted limit increases are used. Until that is sorted out card companies will feel like they have all this extra safe exposure potential from unaccepted limit increases that they desperately want to use up.
As you may imagine, if the lender sees an expected profit on the amount of risk of lending to people in that risk category they will do it. The problem is it is not well solved how to model how much the risk of default changes as you extend someone's debt obligations (known as modeling your credit capacity). This is the sort of tool you need to determine someone's limit.
This hasn't been that much of an issue because a lender usually limits how much they will lend out based on their own available exposure, and they just spread it around to as many borrowers as possible.
But when modeled risk suddenly shrinks the number of profitable borrowers this constraint is no longer sufficient (even if the bank's acceptable exposure is also shrinking). And beyond that, their models are showing they can make up some of their lost profits by lending more into still profitable categories.
There actually do exist a few tools in modeling credit capacity but at the moment they are either crude (like using a flat income to total debt service ratio ceilings) or at the moment unproven. There certainly are people trying to solve this problem, and some institutions may even have working solutions. But it is a problem that not all institutions have solved yet.
Friday, September 10, 2010
If credit is so tight then why do I keep getting offered more credit?
About a week ago I posted as a comment on the Atlantic's business blog. I thought it may be of interest to those who read here as well (the both of you).
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