Credit Score

A credit score is a numerical representation of an individual’s or organisation’s creditworthiness, reflecting their ability to repay borrowed money based on past financial behaviour. It is a crucial indicator used by banks, financial institutions, and lenders to assess the risk of default before extending loans or credit cards. In essence, a credit score summarises a borrower’s credit history into a single three-digit number that helps determine eligibility, borrowing limits, and applicable interest rates.

Concept and Definition

A credit score is derived from a credit report, which records an individual’s borrowing and repayment activities, including loans, credit cards, payment histories, and outstanding debts. It acts as a financial reputation score, showing how responsibly one manages debt.
In most systems, the score ranges between 300 and 900:

• A higher score indicates lower credit risk and greater financial reliability.
• A lower score suggests higher risk and may lead to loan rejection or unfavourable terms.

In India, credit scores are issued by licensed Credit Information Companies (CICs) regulated by the Reserve Bank of India (RBI)—namely:

• CIBIL (Credit Information Bureau (India) Limited)
• Experian
• Equifax
• CRIF High Mark

Among these, the CIBIL Score is the most widely used, typically considered good if it exceeds 750.

Importance of a Credit Score

A credit score plays a pivotal role in the modern financial ecosystem. It affects several aspects of personal and business finance, including:

• Loan Approval: Banks use credit scores to determine an applicant’s loan eligibility.
• Interest Rates: Borrowers with higher scores are offered lower interest rates due to reduced risk perception.
• Credit Card Limits: Higher scores may qualify for higher spending limits and premium credit products.
• Rental and Employment Background Checks: Landlords and employers may check credit reports to assess reliability.
• Insurance Premiums: Some insurers use credit-based scoring to set premium rates.

Components of a Credit Score

Credit bureaus compute credit scores using a weighted model that factors in various elements of financial behaviour. The main components include:

1. Payment History (35%)
   • The most significant factor, showing whether loans and credit card bills were paid on time.
   • Delays, defaults, or missed payments negatively impact the score.
2. Credit Utilisation Ratio (30%)
   • Reflects the proportion of used credit to total available credit limits.
   • High utilisation (above 30%) signals credit dependency and lowers the score.
3. Length of Credit History (15%)
   • A longer, consistent credit record demonstrates stability and responsible borrowing.
   • New borrowers or those without history often have lower or “NA” scores.
4. Type of Credit (10%)
   • A healthy mix of secured credit (home, auto loans) and unsecured credit (personal loans, credit cards) improves the score.
5. Recent Credit Enquiries (10%)
   • Multiple applications for new credit in a short period indicate financial stress and may lower the score.

Credit Score Ranges and Interpretation

A “NA/NH (No History)” score indicates that the person has no credit history—common among new borrowers or those who have never used credit products.

How a Credit Score is Calculated

While each credit bureau uses proprietary algorithms, the general process involves:

1. Collecting financial data from lenders and credit institutions.
2. Assigning weights to factors such as repayment history, outstanding balances, and utilisation ratios.
3. Applying statistical models to compute the final three-digit score.

For instance, the CIBIL Score uses historical data on credit accounts and repayment patterns over the last 24–36 months.

Ways to Improve a Credit Score

Maintaining or improving a credit score requires disciplined financial behaviour. Key steps include:

• Pay bills and EMIs on time: Timely repayment is the single most influential factor.
• Keep credit utilisation below 30%: Avoid maxing out credit cards or overdrafts.
• Avoid excessive loan applications: Too many credit enquiries within a short period can hurt the score.
• Maintain a healthy credit mix: Combine secured and unsecured loans responsibly.
• Review credit reports regularly: Identify and correct errors or fraudulent activities.
• Keep old accounts active: Older credit lines enhance credit history length.

Improvement is gradual; consistent positive behaviour can show results within six to twelve months.

Factors Negatively Affecting Credit Score

Several practices can lead to a decline in credit scores:

• Frequent loan defaults or delayed EMIs.
• Maintaining very high outstanding balances.
• Closing old credit cards with long-standing good history.
• Applying for multiple credit cards or loans simultaneously.
• Ignoring disputes or inaccuracies in credit reports.

Credit Report vs. Credit Score

While related, a credit report and credit score are distinct:

Lenders typically review both before approving credit applications.

Credit Score in India

In India, the RBI mandates all banks and financial institutions to report borrowers’ credit information to credit bureaus monthly. Borrowers are entitled to one free credit report per year from each bureau.
Credit scores have become central to the country’s retail lending ecosystem—banks, NBFCs, and fintech companies use them to offer pre-approved loans, instant credit cards, and differential interest rates.
A CIBIL score above 750 is generally considered optimal for accessing most forms of credit, while scores below 650 often result in higher interest rates or rejection.

Credit Scoring for Businesses

Apart from individuals, businesses also have credit ratings or business credit scores, which assess their creditworthiness based on financial statements, repayment records, and operational stability. These ratings, assigned by agencies such as CRISIL, CARE, and ICRA, influence access to commercial loans and trade credit.

Importance of Credit Scores in the Digital Economy

With the rise of digital lending and fintech innovations, credit scoring models have evolved to incorporate alternative data sources—such as mobile payments, utility bill records, and e-commerce transactions—especially for new-to-credit individuals. This promotes financial inclusion by enabling responsible lending to previously unbanked populations.

Limitations of Credit Scores

While credit scores are useful, they have certain limitations:

• Data dependency: Inaccurate or incomplete lender reporting can distort scores.
• Limited consideration of income: A high-income individual may still have a poor score due to past defaults.
• Bias against new borrowers: Individuals without prior credit history are often penalised with low or “no history” scores.
• Inconsistent scoring models: Slight variations exist between different credit bureaus.