We, the hostages of the bank!

What did you eat?
The Schufa can explain again how they arrive at these score values. They are hardly reliable. That’s one thing. On the other hand: a bank that relies solely on the Schufa score is no bank.

I don’t even want to know what they know about me. They even call me when I go on a spending spree at Amazon and ask if someone has stolen my credit card. Or when I have higher incoming payments in my account, they call and ask what I plan to do with it, if I want to invest it... That scares me much more...

The last bill I ever missed was due to youthful carelessness and was less than 50 marks. Currently, I am at 95.5% with Schufa despite a credit that was not deleted even after a written request and is statute-barred (2000€ for a sofa) and 2 wrong addresses where I have never lived... They managed to delete one after 6 months... Very reliable this organization.

So, now I am home and give a small but fine insight into the world of rating grades, scores, etc... Basically, default probabilities, and that is what it is all about, always have to be considered in relation to a term. Usually, this observation horizon is one year.

Schufa formulates it nicely that with a score of 97%, in 3 out of 100 cases it is likely that a contract will not be fulfilled. First the question: What kind of contract? Well, you just don't know. Furniture purchase? A one-time thing, payment in 14 days or so. Mobile phone contract? Many payments over the next 2 years. Home financing? The next 20, 30, 40 years.

So we probably agree that with a risk of 3% (per year) the risk of default increases year by year.

Now let's take a closer look at the table cited above...

90-95% are still presented as "satisfactory to increased risk." I wonder for whom this is supposed to be the case. Here is an example. I have 20 friends of whom I now claim I would always get my money back. So I lend each of them 100 euros. If even one of them defaults after one year, I am at 95%. If two friends default, then I am already at 90%.

That means I would have already lost 200 of 2000 euros. I have to recover this through a risk premium (not pure interest) from the others. That would be between 5 and 11 euros per remaining friend. In other words, I would have to charge at least 5-11% interest, without having earned a single euro.

Now I increase my number of friends to 100 friends, of whom only 1% default. That would then be about 1 euro surcharge per remaining friend. In other words, 1% alone as a risk premium.

And now back to the banks, which besides the credit default risk also have to pay interest as refinancing and cover costs (employees, buildings, etc.) and then ideally also make a profit. Where does a bank put this 1% risk cost?

I stick to the statement that scores below 99% for home financing are more or less at risk of default. Here is another digression, this time into the world of investments. More precisely into the area of fixed-income investments. These are the things with which banks went under in Greece. Standard & Poor’s rates a bond with the rating BB with a fulfillment probability over a one-year horizon of 99.05%. This investment is literally called "Non Investment Grade Speculative," or also "Speculative investment - in case of deterioration of the situation, defaults are to be expected." Would you as an investor describe this investment as safe, good, or low risk? Hardly.

PS: Of course, securities and equity influence this calculation, but basically this example hits the nail on the head.

What did you eat? The Schufa cannot even say how they arrive at these score values. They are hardly going to be reliable. That is one thing. On the other hand: a bank that relies exclusively on the Schufa score is not a bank

This way the sentence makes sense

You can ask Schufa again how they arrive at these score values.

Correction, Schufa does not want to reveal that. McDonald's also does not disclose the composition of the Big Mac sauce.

They are hardly reliable there. That’s one thing.

It always depends on the observation period and the purpose. On average, the ratings are quite good statistically. Of course, there are exceptions in both directions.

On the other hand: a bank that relies solely on the Schufa score is not a bank.

100% agreement, but it is a good first indicator, even though many banks do not consider the Schufa score at all when financing a home and prefer to make their own assessment. But even those cases will rarely deviate much, unless you have your petty cash well filled, which Schufa does not know.

Sorry, but that's a simplistic calculation you're making. When the bank lends money, not all the other "friends" bear the risk. Certainly to some extent, but not fully. If you build a house on land, that largely represents the default losses when it comes to it. The bank doesn't lose everything. If you give 100 friends 100 € each without having an iPod from each as collateral, it's your own fault...

When the bank lends money, aren't all the other "friends" bearing the risk?

Yes, of course, who else? The executives? The employees? The state? (Oops, that happened temporarily already, see Commerzbank) The investor? (Oops, see Cyprus) Of course, the other borrowers pay for it as well.

Of course, this is a simplistic calculation and I deliberately left out the liquidation proceeds from collateral. This consideration was presented in a simplified manner and referred to unsecured engagements.

Then we just consider the collateral as well. But how do you value the iPod now? Or the house? Banks consider a house at 60% of the lending value as 100% secured. This is called the real credit limit.

Let's say a house has a market value of 120,000 EUR. From that, 30% is deducted and you might get the lending value. Of that, 60% makes 60,000 EUR "secure credit". The remaining 60,000 EUR are again risk-bearing. On the one hand, the borrower's probability of default, on the other hand, the unknown liquidation proceeds of the collateral which exceed the 60,000 EUR.

So instead of 1%, it's still 0.5%, or even 0.4%, or only 0.3%. No bank grants a risk-bearing loan at a rate that is statistically lower than interest + risk premium + costs + profit.