Introduction


This document describes some of the high-level key considerations that in our view are most important for assessing consumer credit risk. Our model looks at an individual as economic unit in a somewhat similar way as the balance sheet, profit and loss statements are commonly assessing credit risks in a corporate setup. We calculate various ratios between the two and determine threshold levels that we deem to be sustainable and healthy or not. In this document we focus on our two main risk categories as well as our general perspective.


Beta risk factors


In finance beta is a measure of risk arising from exposure to general market conditions. It could also be referred to as systematic risk or market risk. In the case of READ such beta risk includes for example your disability and mortality risk, which is driven by factors such as your age, sex, geographic location or industry exposure. Our model assumes that beta risk factors 1) cannot be altered at all and 2) cannot be altered in the short-term. Beta risk is therefore unchangeable for the purpose of our model and while its risk cannot be eliminated, its impact could be covered through insurance.


Alpha risk factors


In modern portfolio and capital asset pricing theory alpha is a measure of over- or underperformance over and above a certain benchmark or market risk, i.e. the beta risk. Alpha can therefore be described as unsystematic or more specifically individual risk. As far as the READ model goes, your spending would be an example of an alpha risk. It is individual to you, but more importantly, we assume in our model that it can be altered. In our rating methodology we refer to alpha risk also as cash-flow risk. In our view, cash flow considerations, especially in the short-term, are key to determine your financial health.


Historic versus Implied risks


Volatility is an important measure to determine the price of a financial asset. It is a statistical indicator of the magnitude of change. In theory, the higher the volatility, the higher the risk. In the context of consumer credit, the interest rate equals the default risk and therefore the price of the consumer debt. There are two main concepts how this can be determined; either you extrapolate historic risk into the future or you calculate an implied risk, based on current or forward-looking data. Given the possibility of significant discrepancies between 1) historic and current risk measures, and 2) aggregated and individual risk calculations, our model puts emphasis on providing a forward-looking and individual risk assessment. In principal at READ we believe that the past performance is potentially a misleading or inaccurate indicator to predict the future performance. The READ algorithms therefore use implied or predictive risk data as opposed to historic numbers. We do however use historic and aggregated data as a comparative baseline to determine if the current and individual risk assessment is above or below long-term aggregated averages.


Rating


Our credit rating reflects the general creditworthiness of an individual to meet his or her current and future financial obligations associated with his or her existing consumer credit exposure based on our algorithmic model. Our calculations are reliant on the quality of the information provided by the individual and do not include any information not captured, which might significantly impact the economic reality of the individual creditworthiness. While the required customer data can be verified independently, our credit rating does not support this function and therefore neither guarantees an individual creditworthiness nor does it constitute an assessment of the ability to increase or decrease consumer credit exposure. Our rating is aimed at providing an independent 3rd party view of the individual default probability, which requires to be paired with a separate data verification process by the lender.


Rating

Description

A+

Very strong.

The individual has a very low likelihood to default. The financial position is very strong to meet future financial obligations. The individual is minimally leveraged.

A-

Strong.
The individual has low likelihood to default. The financial position is strong to meet future financial obligations. The individual has modestly leveraged.

B+

Average.
The individual has an average likelihood to default. The financial position is sufficient to meet future financial obligations. The individual is intermediately leveraged.

B-

Below average.

The individual has an average likelihood to default. The financial position is sufficient to meet future financial obligations. The individual is significantly leveraged.

C+

Weak.
The individual has a high likelihood to default. The financial position is not sufficient to meet future financial obligations. The individual is aggressively leveraged.

C-

Vulnerable.
The individual has a very high likelihood to default. The financial position is not sufficient to meet future financial obligations. The individual is highly leveraged.

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