Do you want to know “how banks rate you when you borrow money from banks”?

singapore-218528_1280

Hi friends,  I am Toshi, This is my weekly letter. This week’s topic is “how banks rate you when you borrow money from banks”. When we want bank loans, it is good that we can borrow the amount of money we need,  with a lower interest.  Then I am wondering how banks decide who can borrow the amount of money requested with lower interests. In other words, how banks assess customer’s credit worthiness.  The answer is “Classification”.  Let me explain more details. To make the story simple,  I take an example of  unsecured loans, loans without collateral.

 

1.  “Credit risk model” makes judgements to lend

Now many banks prepare their own risk models to assess credit worthiness of customers.  Especially global banks are required to prepare the models by regulators, such as BIS, FSA and central banks. Major regional banks are also promoted to have risk models to assess credit worthiness.  Regulations may differ from countries to countries,  by size of banks.  But it is generally said that banks should have their risk models to enhance credit risk management.  When I used to be a credit risk manager of the Japanese consumer finance company, which is one of  the group companies in the biggest financial group in Japan,  each customer is rated by credit risk models. Good rating means you can borrow money with lower interest. On the other hand, bad rating means you can borrow only limited amount of money with higher interest rate or may be rejected to borrow. From the standpoint of management of banks, it is good because banks can keep consistency of the lending judgements to customers among the all branches.  The less human judgement exists, the more consistency banks keep.  Even though business models may be different according to strategies of banks, the basic idea of the assessment of credit worthiness is the same.

 

2. “Loan application form” is a starting point of the rating process

So you understand credit risk models play an important role. Next, you may wonder how rating of each customer is provided.  Here “classification” works. Let me explain about this.  When we try to borrow money,  It is required to fill “application forms”. Even though the details of forms are different according to banks,  we are usually asked to fill “age” “job title” “industry” “company name” “annual income” “owned assets and liabilities” and so on.   These data are input into risk models as “features”.   So each customer has a different value of “features”.  For example, someone’s income is high while others income is low.   Then I can say  “Features”of each customer can explain credit worthiness of each customer.   In other words,  credit risk model can “classify”  customers with high credit worthiness and customers with low credit worthiness by using  “features”.

 

3.  Rating of each customer are provided based on “probability of default

Then let us see how models can classify customers in more details. Each customer has values of “features”  in the application form. Based on the values of “features”, each customer obtains his/her own “one value”.  For example, Tom obtains “-4.9” and Susum obtains “0.9” by adding “features” multiplied with “its weight”.  Then we can obtain “probability of default” for each customer.  “Probability of default” means the likelihood where the customer will be in default in certain period, such as one year. Let us see Tom’s case. According to the graph below,  Tom’s probability of default, which is shown in y-axis, is close to 0.  Tom has a low “probability of default”. It means that he is less likely to be in default in the near term. In such a case,  banks provide a good rating to Tom. This curve below is called “logistic curve” which I explained last week. Please look at my week letter on 23 April.

logistic2

Let us see Susumu’s case. According to the graph below,  Susumu’s probability of default, which is shown in y-axis, is around 0.7, 70%.  Susumu has a high probability of default. It means that he is likely to be in default in the near term. In such a case,  banks provide a bad rating to Susumu. In summary,  the lower probability of default is,  the better rating is provided to customers.

 

logistic1

Although there are other methods  of “classification”,  logistic curve is widely used in the financial industry as far as I know. In theory, the probability of default can be obtained for many customers from individuals to big company and sovereigns, such as “Greeks”.  In practice, however, more data are available in loans to individuals and small and medium size enterprises (SME) than loans to big companies.  The more data are available, the more accurately banks can assess credit worthiness. If there are few data about defaults of customers in the past,  it is difficult to develop credit risk models effectively. Therefore, risk models of individuals and SMEs might be easier than risk models of big companies as more data are usually available in loans to individuals and SMEs.

I hope you can understand the process to rate customers in banks. Data can explain our credit worthiness, maybe better than we do. Data about us is very important when we try to borrow money from banks.

“Classification” is significantly useful for our business, isn’t it?

public-domain-images-free-stock-photos-high-quality-resolution-downloads-public-domain-archive-14

Hello, I am Toshi. Hope you are  doing well. Now I consider how we can apply data analysis to our daily businesses.  So I would like to introduce “classification” to you.

If you are working in marketing/sales departments, you want to know who are likely to buy your products and services. If you are in legal services, you would like to know who wins the case in a court. If you are in financial industries, you would like to know who will be in default among your loan customers.

These cases are considered as same problems as “classfication”.  It means that you can classify a thing or an event you are interested in from all populations you have on hand.  If you have data about who bought your products and services in the past, we can apply “classification” to predict who are likely to buy and make better business decisions. Based on the results of classification,  you can know who is likely to win cases and who will be in default with a numerical measure of certainty,  which is called “probability”.  Of course, “classification” can not be a fortune teller.  But “classification” can provide us who is likely to do something or what is likely to occur with some probabilities.  If your customer has 90% of probabilities based on “classification”, it means that they are highly likely to buy your products and services.

 

I would like to tell several examples of “classification” for each business. You may want to know the clues about the questions below.

  • For the sales/marketing personnel

What is the movie/music in the Top 10 ranking in the future?

  • For personnel in the legal services

Who wins the cases ?

  • For personnel in the financial industries or accounting firms

Who will be in default in future?

  • For personnel in healthcare industries

Who is likely to have a disease or cure diseases?

  • For personnel in asset management marketing

Who is rich enough to promote investments?

  • For personnel in sports industries

Which team wins the world series in baseball?

  • For engineers

Why was the spaceship engine exploded in the air?

 

We can consider a lot of  examples more as long as data is available.  When we try to solve these problems above,  we need data in the past, including the target variable, such as who bought products, who won the cases and who was default in the past.  Without data in the past, we can predict nothing. So data is critically important for “classification” to make better business decisions.   I think data is “King”.

 

Technically, several methods are used in classification.  Logistic regression,  Decision trees,  Support Vector Machine and Neural network and so on. I recommend to learn Logistic regression first as it is simple, easy to apply real problems and can be basic knowledge to learn more complex methods such as neural network.

 

I  would like to explain how classification works in the coming weeks.  Do not miss it!  See you next week!

Mobile services will be enhanced by machine learning dramatically in 2015, part 2

iphone-518101_1280

Happy new year !   At the beginning of 2015,  it is a good time to consider what will happen in the fields of machine learning and mobile services in 2015.  Followed by the blog last week,  we consider recommender systems and internet of things as well as investment technologies. I hope you can enjoy it !

 

3. Recommender systems

Recommender systems are widely used from big companies such as amazon.com and small and medium-sized companies.  Going forward,  as image recognition technology progresses rapidly, consumer generated data such as pictures and videos must be taken to analyze consumers behaviors and construct consumers preferences effectively.  It means that unstructured data can be taken and analyzed by machine learning in order to make recommendations more accurate. This creates a virtuous cycle. More people take pictures by smartphones and send them thorough the internet, more accurate recommendations are.  It is one of the good examples of personalization. In 2015 a lot of mobile services have functions for personalization so that everyone can be satisfied with mobile services.

 

4. Internet of things

This is also one of big theme of the internet.  As sensors are smaller and cheaper,  a lot of devices and equipments from smart phone to automobile have more sensors in it. These sensors are connected to the internet and send data in real-time basis.  It will change the way to maintain equipments completely.  If fuel consumption efficiency of your car is getting worse, it may be caused by failure of engines so maintenance will be needed as soon as possible. By using classification algorithm of machine learning, it must be possible to predict fatal failure of automobiles, trains and even homes.  All notifications will be sent to smartphones in real-time basis. It leads to green society as efficiency are increasing in terms of energy consumption and emission control.

 

5. Investment technology

I have rarely heard that new technologies will be introduced in investment and asset management in 2014 as far as I concerned.  However I imagine that some of fin-tech companies might use reinforcement learning, one of the categories of machine leaning.  Unlike the image recognition and machine translation, right answers are not so clear in the fields of investment and asset management. It might be solved by reinforcement learning  in practice in order to apply machine learning into this field. Of course, the results of analysis must be sent to smart phone in real-time basis to support investment decisions.

 

Mobile services will be enhanced in 2015 dramatically because machine learning technologies are connected to mobile phone of each customer. Mobile service with machine learning will change the landscape of each industries sooner rather than later. Congratulations!

 

Financial industry and artificial intelligence

money-glut-432688_1280

UBS announced that it will deliver personalized advice to the bank’s wealthy clients by using artificial intelligence (AI). UBS plans to roll out a digital service in Asia next April.

I think this is one of the example for financial institutions to go to “digital personalized marketing”  by artificial intelligence.  In future  personalized services by AI are one of the key strategic technologies in the financial industry. Let us consider how artificial intelligence are implemented and used in marketing of  financial industries more details.

 

1. data

This is a basis for the analysis to predict what financial products customers want.  According to this article about UBS, in the presentation by founders of Sqreem, they said that they crawl through a wide range of openly available, unstructured data. I would like to explain unstructured data. It means the data is not organized in a database as we usually see. So I assume massive amount data could be gathered automatically.  Data might be gathered in real-time basis so final outputs such as recommendations also might be provided in real-time basis. It is a dynamic process, rather than a static process.

 

2. algorithm

There is no disclosure about how calculations are done in details as far as I know. So this is my assumptions based on the article.  This might be one of the recommender systems. As the article says, this focuses on the behavior of customers.  Behavior of customers could be identified in deeper level and precise recommendations to individual customers could be  provided effectively.  In my thought,  this system might be on-line learning system, too. It means that algorithm could learn new things by themselves, could be updated based on stream data in real-time basis and adjust the change of customers’ preferences.

 

3. output

This is also my assumptions based on the article. The articles mentioned mobile phones and other digital devices.   I think recommendations might be mainly provided to individual customers through their mobile phones. Mobile phones could be personal interface against banks and financial institutions.  One of the biggest advantage of mobile phones is that customers preference could be gathered through interaction between customers and banks without any official inquiry to the customers.

 

This is not the end of story but the beginning of it.  As technology is progressed,  a lot of industries will try to introduce such kind of personalized recommender systems. This is marketing of digital era so that everyone can obtain the best products and services among a lot of choices. How wonderful it is !