Introduction to Online Payments Risk Management

Chapter 3. The Two Leading Approaches to the Analysis and Optimization of Losses

Once we understand what we’re trying to achieve, we need to understand how we get there. How do we reduce the percentage of rejected customers and losses? There are two complementary approaches to this problem.

The Portfolio Approach

This approach looks at the company’s portfolio of customers top down and looks for optimizations regardless of individual customers’ behavior. This means that to reduce losses and rejections we need to provide an inflow of better customers—target safer industry segments, attract repeat consumers with lower risk profiles, etc., as well as block segments of ill-performing ones. If we need a shift in losses or rejections for a market or a large merchant, we can adjust our scoring threshold (which means a change to the trade-off between rejections and losses) to accept more or fewer consumers. Accordingly, this approach supports certain types of modeling and reporting that allow it to be effectively applied. The portfolio approach is most effective when dealing with long credit times: e.g., credit card, auto, and mortgage portfolios. This is because credit trends are local, sometimes hyperlocal, and are greatly impacted by macroeconomic trends not only for new applications (when I refer to principles relevant to both consumers and merchants, I use the term application(s)) but also in existing loans’ due payments. The portfolio approach and its related modeling techniques have ...