Risk management is often viewed as a cost center.

Can a return be derived from good credit risk modeling?

Assume

Population comprises 30% Good and 70% Bad credit risks.

Good PD = 0.01 and Bad PD = 0.20

NII = 2% and LGD = 20%

Estimate the expected return of a $100 loan if the bank approves credit applications randomly.

Bank develops a credit risk model with the following Misclassification Matrix.

Predicted Actual	Active	Default	Total
Active	58%	4%	62%
Default	2%	36%	38%
Total	60%	40%	100%

Estimate the expected return of a $100 loan if the bank approves credit applications using the credit risk model developed.

Compare the payoffs of random and model-based decisions.