Page 1

Application of Fuzzy Logic to

Individual Debt Appraisal and
Analysis
Dissertation

Submitted in partial fulfillment of the requirements for

the degree of
Bachelor of Technology
By
Aman Bafna
Entry No: 2011EE10440
Vivek Ranjan Maitrey
Entry No: 2011EE10494
under the guidance of
Prof. SMK Rahman

Department of Electrical Engineering

Indian Institute of Technology, Delhi
2014

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Dissertation Approval Certificate

Department of Electrical Engineering
Indian Institute of Technology, Delhi

The dissertation entitled Application of Fuzzy Logic to Individual Debt

Appraisal and Analysis, submitted by Aman Bafna (Entry No:
2011EE10440) and Vivek Ranjan Maitrey (Entry No: 2011EE10494) is
approved for the award of B. Tech in Electrical Engineering from
Indian Institute of Technology, Delhi.

Signature: ....
Professor S.M.K. Rahman

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Declaration
I declare that this written submission represents my ideas in my own
words and where others ideas or words have been included, I have
adequately cited and referenced the original sources. I also declare that I
have adhered to all principles of academic honesty and integrity and have
not misrepresented or fabricated or falsified any idea/data/fact/source in
my submission. I understand that any violation of the above will be cause
for disciplinary action by the Institute and can also evoke penal action
from the sources which have thus not been properly cited or from whom
proper permission has not been taken when needed.

Signature:
Name: Aman Bafna
Roll No: 2011EE10440
Signature:
Name: Vivek Maitrey
Roll No: 2011EE10494

Date:

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Abstract
Due to increasing uncertainty in financial markets and risks because of
greater interconnectivity of the world, analyzing credit worthiness of a
company/individual has become very important. In India specially, the
NPAs of major banks has been steadily growing. Hence it is important to
have a sound mathematical model which can calculate the risk associated
with a particular loan. This paper explores the afore-mentioned problem
using Fuzzy Logic and Fuzzy Interface System.

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Acknowledgements
We would like to thank our guide Prof. SMK Rahman for his constant
guidance and support. His knowledge and eye for detail have helped us to
learn and produce more in the given time duration

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Contents
1

Introduction ...............................................................................................................
1.1

Problem Definition ..........................................................................................

1.2

Organization of the Report ...........................................................................

Literature Review .................................................................................................

Artificial Neural Networks ........................................................................ 10

2.2

Regression Analysis............................................................. 10

2.3

Fuzzy Logic............................................................................................. 11

Methodology ...........................................................................................................

12

Identification of Crisp Inputs................................................................. 12

3.1.1

Debt Ratio .................................................................................................. 13

3.1.2

Loan To Value Ratio............................................................. 13

3.1.3

Debt Coverage Ratio.... 13

3.1.4

Priority Sector + Prior Bank Customer.. 14

3.1.5

Online Retail Default .... 15

3.1.6

Bill Payment Default .... 15

3.1.7

Bank Transaction Default.. 15

3.2

Mamdani System ........................................................................................... 25

Data and Results ....................................................................................................

4.1

10

2.1

3.1

28

Working of Credit Score............................................................................... 26

Conclusions .............................................................................................................. 28

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List of Figures and Tables

Figure 1: Fuzzy Logic Flow Chart .20
Figure 2: Fuzzy Interface System ..20
Figure 3: Rule Editor for Fuzzy Interface System....21
Figure 4: Debt Ratio Fuzzy Set ...22
Figure 5: Loan To Value Ratio Fuzzy ..22
Figure 6: Debt Coverage Ratio Fuzzy Set .23
Figure 7: Priority Sector +Prior Bank Customer Fuzzy Set .23
Figure 8: Online Retail Default ..23
Figure 9: Bill Payment Default ..........23
Figure 10: Bank Defaults ....24
Figure 11: Output Finction ......24
Table1: Fuzzy Inputs.22
Table 2: Credit Score For different individuals30

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Chapter 1
1 Introduction

Banking like any business is not without its risks. The whole banking
system is based on the premise of extending credit to those who need it
and in turn get interest on the amount disbursed. In this era of
globalization financial systems all around the world have become
interconnected. No nation can remain insulated from developments
taking place even on the other side of globe. The most recent example of
this was the Sub Prime crisis in the United States, which brought about a
global economic meltdown.
The Sub Prime crisis was called so because banks extended loans to even
hose customers which did not have the financial soundness to repay the
loan. The banks started getting accumulated with mortgaged properties.
The sudden increase in properties in the open market further drove down
the prices prompting more customers to default on their loans. This
vicious cycle continued and the major financial giants crashed.
Banks are the backbone of the current financial system. They are the
gateway to the complex world of credit. It is imperative that banks remain
in proper financial health for the smooth functioning of the economy.
Banks are becoming increasingly vigilant and keep constant check on bad
loans after it became abundantly clear that the recent 2008 recession was
caused by aggressive lending by leading banks.
The key to check the rise of bad loans is to differentiate between a prime
customer and a sub-prime customer. Often banks treat prime and subprime customers differently. Prime Lending Rate significantly lower than

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the normal lending rate of banks as there is lower risk of default. It
becomes imperative to make this distinction.
The best way to avoid a bad loan is to not provide loan to unworthy
debtor in the first place. Hence banks spend a lot of resources on loan
analysis.

Current

methods

involve

long

questionnaires

and

comprehensive background checks. Interviews of applicants are

conducted during the process. However these methods have certain
inherent problems. Certain terms are vague and subjective in nature. The
process is also prone to personal and political influences. Hence an
objective scheme is desired that is free from these drawbacks.

1.1 Problem Definition

To build a model based on fuzzy logic that will help in debt appraisal. The
model will provide a fuzzy score to every individual assesse based upon
which banks will decide to approve the debt or not.

1.2 Organization of the Report

The organization of this report is as follows. Chapter 2 provides the
literature review. Theory necessary to proceed for this study has been
summarized. Methodology and work flow of the simulation has been
discussed in chapter 3. The detailed results of the experiments have been
presented in chapter 4. Chapter 5 contains conclusions of this study.

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Chapter 2
Literature Review
Several strategies are available for mathematical modeling of systems
ranging in complexity and scale. Some of the most popular schemes
employed for financial modeling are :
2.1 Artificial Neural Networks (ANNs)
A neural network is a system composed of many simple processing elements
operating in parallel whose function is determined by network structure,
connection strengths, and the processing performed at computing elements
or nodes [1]
Artificial neural networks are highly adaptive non-linear computational
models that successfully discover complex relationships between the inputs
and output. However the major disadvantages of ANNs are their
computational intensive nature and the opaque nature of the model which
makes calibration difficult. They are usually avoided in favor of simpler,
faster models.

2.2 Regression Analysis

Regression analysis may be employed to find out the relationship between
two more variables. Regression analysis is especially useful when we have to
determine one quantitative which is a function of two or more independent
variables. [2]
For example a multivariate regression would relate credit worthiness of an
individual in the following manner
Y = a+ bX1+cX2+dX3
(1)
Where Y is some variable to measure the credit worth of an individual; X1,X2
and X3 are variables representing common financial ratios such as Loan to
Value Ratio or Debt Service Coverage Ratio; and a,b,c and d are constants.
However regression analysis suffers from one major limitation that is the
assumption of linearity between the input variables and the output which
may not always be the case, which makes it unsuitable for the complexities of
financial world.

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2.3 Fuzzy Logic
Fuzzy set theory is widely used to model inaccuracy and uncertainty of real
world. Fuzzy logic is a form of many-valued logic; it deals with reasoning
that is approximate rather than fixed and exact. Compared to traditional
binary sets (where variables may take on true or false values), fuzzy logic
variables may have a truth value that ranges in degree between 0 and 1.
Fuzzy logic has been extended to handle the concept of partial truth, where
the truth value may range between completely true and completely false.[2]
Fuzzy logic is well suited for the purpose of loan assessment because it
closely resembles the discourse of loan appraisal. The fuzzy approach uses
fuzzy sets to model the linguistic description of the financial conditions.
The process to construct a fuzzy model consists of three steps:
1. Fuzzification
2. Construction of rule base
3. Defuzzification
Fuzzification: Every fuzzy variable in the model is associated with a linguistic
description. The variables which take on a numerical value are assigned a
linguistic variable. This step essentially converts the raw financial statistics
into a linguistic assessment. It involves mapping the crisp input variable onto
a membership function which maps it onto fuzzy sets. Every fuzzy variable is
classified into Very Bad, Bad, Normal, Good and Very Good.
Construction of rule base: The rule base consists of IF-THEN rules. The
structure of the rule base is founded upon the requirements of the bank.
The former evaluates the extent to which the objects satisfy the
requirements, and the later represents the response of the system.
Defuzzification is the last process of the model. The contribution from each of
the IF THEN rules is compressed into a single variable. There are several
methods for defuzzification, the most commonly ones used being the
weighted average and centroid location.
Advantages of using a Fuzzy approach to credit appraisal:
1. Subjective nature of inputs: The 5 Cs of credit Capacity, Capital,
Collateral, Conditions and Character are the inputs for making the
decision of loan approval. Loan officers try to capture as much
information about the customer from his balance sheet, income
declaration and banking records to evaluate the degree of potential
risk. These inputs have to be identified in ambiguous terms like good,

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above, below etc. Any decision that involves such ill defined terms
will be prone to error of judgment. The strength of the fuzzy approach
lies in its ability to capture this approximate reasoning through its use
of fuzzy sets.
2. Imperfect Data: In the real world, the data is never well defined. Often
some of the data is missing or changing too often to be used for a
mathematical model. When the variables are themselves ill defined,
there is scope for misinterpretation. The variables may vary in scale
from customer to customer.
3. Adaptability: The fuzzy approach relies on the definition of
membership functions for the crisp variables. For example, the loan to
value ratio is considered to be good in the range 40%-60% but if
credit is available freely, banks may simply move this window to
45%-60%. This adaptability makes it ideal for the ever changing
world of finance. The rules base itself can be modified from time to
time.

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Chapter 3
3 Methodology
Identification of Crisp Inputs:
The first step in construction of a fuzzy model is the identification of crisp
inputs. There are several financial ratios that have are widely used for the
assessment of financial soundness. It is time tested method of financial
analysis. The most important advantage of using financial ratio is that
they neither sophisticated nor difficult to follow. Financial ratios are
simple comparisons between two figures gathered from the income
statement of an individual. Since these are ratios from the statistics of the
same individual, they allow for comparison between different applicants
based on their financial health even if there is huge disparity in the
amount of credit solicited.
Capacity, Capital, Collateral, Conditions and Character are considered to
be the 5 Cs of credit analysis. We will try to capture these variables for
our assessment. Since none of these variables are directly measurable,
certain financial variables will be used as proxies. These variables
however do not hold equal weightage. The most commonly used financial
ratios to evaluate the above are the following:
1. Debt Ratio : It is the ratio of total debt to total assets of an individual
expressed as a percentage. It can be interpreted as the proportion of a
customers assets that are financed by debt.

[4]

If the debt ratio of a

customer is too high, he will most probably be denied credit. Most

banks have a ceiling on the debt ratio and sometimes it is also set by
the central banks. Too high a debt ratio reduces the capacity of a
customer to borrow more. Generally 42% is upper limit on the debt
ratio. Debt ratio in the range 21%-42% is considered worrisome. Debt
ratio in the range 16%-19% is considered moderate, in the range 6%-

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16% it is considered favourable. Anything less than 6% is a very good
debt ratio and qualifies you to get more credit.
2. Loan to Value Ratio: It is another very important financial ratio in risk
assessment. It the ratio of the principal of the debt being solicited to
the value of the collateral submitted to the bank. The collateral is the
final assurance of the bank for the repayment of debt. In case of failure
by the customer to service his debt, the banks take custody of the
collateral and auction it in the open market to recover their debt. If the
market value of the collateral is high, you are entitled to larger credit.
Higher loan to value ratios translate into greater risk for the bank
because they will need to sell the collateral at a higher price to recover
their debt. While if the loan to value ratio is less, the customer is more
likely to ensure repayment of debt.
In our analysis, we have taken the housing sector as the example.
Since residential properties are appreciating assets, banks allow loans
up to 80% of the market value of the collateral.
3. Debt Service Coverage Ratio: It is the ratio of cash available to the
principal and interest liabilities of the customer. It is an indispensable
component of risk assessment because it is the income through which
the debt will be serviced. Ideally any ratio greater than should be
acceptable to the banks because the customer can meet his payments,
but is never the case. This is because the debt service coverage ratio
only measures the capacity of a customer to earn its debt service not
the amount of cash available to meet his obligations. The customer
may divert his/her earnings for other enterprises, tax liabilities or to
support his/her lifestyle. Acceptable industry norm for a debt service
coverage ratio is between 1.5 to 2. [5]
The above financial ratios are used to estimate the first three Cs namely
Capacity, Capital and Collateral. The remaining two Cs have to estimated
by other means.
Conditions also influence the terms of the loan. Conditions describe the
purpose of the loan whether it is capacity addition, business expansion or
personal consumption. They also include specific directions by RBI and
the government regarding engagement with certain sectors. For example,

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if the purpose of the loan is buying gold, the banks may issue loan only
upto 65% of the amount in the transaction. This is intentionally done to
keep people away from consuming gold which burns into the nations
foreign exchange reserves.

At the same time, loans for agricultural

activities like buying seeds, fertilizers and farming equipment may be

granted loan up to 100% of the transaction amount. This has been done to
encourage farmers to adopt modern agricultural practices and save them
from local loan sharks. The most important conditions influencing the
loan approval processes are:
1. Purpose of Loan/Priority Sector Lending: Even within the priority
sector lending scheme, there are two categories of assistance. Direct
and Indirect Finance. Direct Finance is to help the small and
marginalized farmers directly by providing cheap and timely credit
assistance. Bigger loans to business majors for agricultural purposes
are considered as Indirect Assistance because they create employment
opportunities for rural work force. If the purpose of loan falls under
Direct Assistance Category, it gets a +2 score on a scale of 1 to 5. Loans
falling under Indirect Assistance get a +1 on their Conditions score.
2. Prior Bank Records: Banks usually reward loyal customers by easily
approving their loans. A bank record of 5-10 years will get a +1 on
their conditions score, 10-15 years will get a+2 and anything above 15
years will fetch a +3.
The fifth C, the Character of the consumer is the most difficult to quantify.
It is very important to differentiate between responsible, reasonable
customers and irresponsible borrowers. During the classification of the
customers into responsible and irresponsible customers, there may be
errors of the following types. Type I error occurs when a worthy applicant
is flagged as unworthy debtor. In this this case the interest which could
have been made on a loan is lost. Type II error occurs when an unworthy
applicant is flagged as worthy debtor. In this case even the principal along
with the interest is at risk. Misclassification cost of a Type II error is
usually much greater than that for a Type I error. Any model for
assessment must be not prone to Type II errors.
To assess whether a customer is responsible customer or not we will use
the following indicators:

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1. Online retail default rate: With the increase in popularity of ecommerce in India, there is an increase in the data available for
behavioral analysis of the customer. The recent growth in electronic
transactions has facilitated accumulation of user data which may be
mined for critical insights into the spending habits of the customer. In
India, on the other hand, cash on delivery is the payment method for
up to eight in 10 transactions. We can use this data to differentiate
between responsible and irresponsible customers. A responsible
customer would order what he/she needs and honor the cash
commitment when the item is delivered. On the other hand, an
irresponsible customer is likely to order without giving much thought
and change his/her mind partly because there is no upfront
commitment to pay. The average default rate on Cash On Delivery
(COD) payments is quite high in India at the moment (35-45%).
2. Bill payment default rate: Invariably all people use public utility
systems, be it electricity, water, broadband, mobile or piped gas. Once
again, a reliable customer is more likely pay his utility bills regularly
and on time. Consumer behavior reports generated from these
payment patterns are closer to reality because there is no immediate
penalty for late submission of bills and there is no fear of supervision.
3. Bank credit default rate: With the increasing popularity of electronic
transactions, credit cards/debit cards are readily being adopted by the
Indian populace. These cards permit you to spend more than the cash
available with you. However, you have to pay the overdraft within a
stipulated amount of time, lest you incur penalty in form of interest.
Responsible customers pay their dues in time and are particularly
careful about deadlines. Such customers are likely to meet their
liabilities regularly. Bank credit default rates are around 4% and
anyone around this rate is a safe bet. [6]
After identifying the variables that will act as the crisp inputs, we need to
define the membership functions that govern the rule base. A number will
be produced based upon evaluation according to the rules base. Decision
would be made according to this score.

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Crisp Inputs
Fuzzifcation
Rule Base
Evaluation
Defuzzication
(obtaining the credit score)
Decision
Figure 1: Flow chart of fuzzy logic
Figure 1

Working of the Credit Score

A credit score is a numerical expression based on a level analysis of a
person's credit files, to represent the creditworthiness of that person.[1]
Credit scores find utility in the evaluation of potential risk in lending to
customers. Using the credit scores banks are able to predict how likely is it
for a customer to repay his debt or service his obligations.
Credit scores were developed in an attempt to evaluate the credit worth of an
individual in a fair and objective manner. Since credit worth is highly
subjective in nature and thus prone to variation in analyses by different
individuals.
Credit scores reflect your current financial soundness, ability to meet your
obligations, how faithfully youve paid your bills and anything that somehow
may affect your credit worth. All that information and more can be captured
in a three digit number.

The credit score produced by our fuzzy model is after all a score. It doesnt
decide whether the loan is going to be approved or not. However, a good
score on the model clearly enhance the chances of the debt getting approved.
The credit score in our model varies from 0-320, with 320 being the best
possible credit score. The credit score serves he following purposes:

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1. Uniform parameters to assess all individuals: By using the same

methodology on all potential customers, banks can differentiate prime
customers with the sub-prime customers.

2. Credit pricing: Since a lower credit score on the model indicates more risk
of default, banks can set the price of credit different for different customers.
Prime Lending Rate, the rate at which prime customers are granted loans is
50 to 100 basis points lower than the general lending rate. Banks can thus
balance their risk with more profit. This scheme is generally employed to
reward loyal customers and dissuade customers from defaulting.
3. Managing their credit portfolios: Banking laws in India have been made to
cater to the specific economic and social profile of Indian customers. Priority
Sector Lending is scheme has been implemented to benefit those people who
are the fringes of the market economy. According to the scheme 18 per cent
of the total credit disbursed by the banks has to go to specific sections of the
society like people engaged in agriculture and allied activities, fisheries, selfhelp groups, food processing etc. If they fail to do, banks have to deposit an
amount equal to the shortfall in their lending quota with the NABARD
(National Bank for Agricultural and Rural Development). For customers
belonging to these sections can set a different qualifying score in order to
meet their targets.
4. Managing equity : Sometimes banks borrow from the market when credit
is freely available for example the easy money policy of the Federal reserve.
During times like this credit is in abundant supply hence it makes economic
sense to expand their customer base by simplifying the requirements for the
qualification of loan. If credit supply decreases and cash with the bank dries
up, bars can be set up higher.
5. Managing Economic cycles: All economies undergo boom/recession cycles.
During economic boom, banks lend credit aggressively as economic activity
is at its maximum level. Business expansion takes place at a rapid pace and
all sectors of the economy do well. However during such times, asset bubbles
might be created. Investors in speculation of rising prices of assets, invest
into them by borrowing from banks. Banks relying on the increasing value of
the collateral issue credit easily. When these asset bubbles burst, prices go
spiraling down, prompting others debtors to default on their loans. Banks are
then flooded with mortgaged assets which are not readily sold on the market.

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Cash with the bank dries up and its non-performing assets increase sharply.
As the financial health of banks deteriorates, all other sectors of the economy
are also affected. This is exactly what happened in 2008 Sub-prime crisis, the
effects of which are still being experienced. During boom period of the
economic cycle, banks can use higher benchmarks for approval of loans to
prevent the creation of asset bubbles.

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Fuzzy Model- Mamdani Fuzzy Logic Controller-

The most commonly used fuzzy inference technique is the Mamdani method
which was proposed by Mamdani and Assilian[9] to control a steam engine
and boiler combination by synthesizing a set of linguistic control rules
obtained from human operators of the machine. In Mamdanis model the
fuzzy implication is modeled using the minimum operator of Mamdani, min
is the conjunction operator, t-norm for composition is min and max operator
is used for aggregation. We have used the Mamdani system because of its
simplicity. The other technique is the sugeno method.
Advantages of Mamdani system over Sugeno method

It has widespread acceptance.

It is more intuitive.

It is more robust in the presence of noisy input data.

It is less sensitive to significant imprecision in the inputs than Sugeno.

This happens when the fuzzy sets overlap.

It has less processing time as compared to Sugeno.

Fuzzy Interface SystemMatlab has a very good Fuzzy Interface System, which makes modelling of a
fuzzy system very easy.

Figure 2- Fuzzy Interference System

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Working of the Mamdani Model [2]Step 1 FuzzificationThe crisp inputs are taken and the degree to which they belong to the
appropriate fuzzy sets is calculated.
Step 2 Rules evaluationThe fuzzified inputs are then applied to the antecedents of the fuzzy rules. If
a given fuzzy rule has multiple antecedents, the fuzzy operator (AND or OR)
is used to obtain a single number that represents the result of the antecedent
evaluation. To evaluate the disjunction of the rule antecedents, one uses the
OR fuzzy operation. Typically, the classical fuzzy operation union is used:
AB(x) = max {A(x), B(x)}.
Similarly, in order to evaluate the conjunction of the rule antecedents, the
AND fuzzy operation intersection is applied:
AB(x) = min {A(x), B(x)}.
Now the result of the antecedent evaluation can be applied to the
membership function of the consequent.

Figure 3 Rules for the FIS

Step 3: Aggregation of the rule outputs

The membership functions of all rule consequents previously clipped or
scaled are combined into a single fuzzy set
Step 4: Defuzzification
The most popular defuzzification method is the centroid technique. It finds a

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point representing the center of gravity (COG) of the aggregated fuzzy set A,
on the interval [a, b]. A reasonable estimate can be obtained by calculating it
over a sample of points.

Term
Debt Ratio
Loan to Value
ratio
Debt Coverage
Ratio
Priority Sector+
prior bank
history
Online retail
default
Bill payment
default
Bank default

1(very
bad)
>0.42
>0.90

2(bad)

3(normal)

4(good)

0.21-0.42
0.80-0.90

0.16-0.20
0.60-0.80

0.06-0.15
0.40-0.60

5(very
good)
0-0.06
<0.40

<1.2

1.2-1.3

1.3-1.5

1.5-2

>2

0-1

1-2

2-3

3-4

4-5

>0.5

0.4-0.5

0.2-0.4

0.1-0.2

0-0.1

>0.3

0.2-0.3

0.1-0.2

0.05-0.1

0-0.05

0.04-0.11

0-0.04

>0.2

0.15-0.2
0.11-0.15
Table 1: Fuzzy Inputs

Following are the fuzzy sets assigned to the inputs1. Debt Ratio

Figure 4

2. Loan to value Ratio

Figure 5

Page 23

3. Debt Coverage Ratio

Figure 6

4. Priority Sector+ prior bank history

Figure 7

5. Online retail default

Figure 8

6. Bill payment default

Figure 9

Page 24

7. Bank default

Figure 10

Output Function
The output function is divided in 16 membership functions that denote different
credit ratings from the worst (D) to the best (AAA).

Figure 11

RULESWe have used 172 rules to make the system as robust as possible and to
account for all the variations in the input variables. The rules are in the code
below in the form1 1 1 1 1 1 1, 1 (1) : 1
This means if (Debt ratio is very bad(1)) and (loan to value ratio is very
bad(1)) and (Debt coverage ratio is very bad(1)) and (priority sector+ prior
bank customer is very bad(1)) and (online retail default is very bad(1)) and
(bill payment default is very bad(1)) and (bank default is very bad(1) then
output is D (i.e. the worst credit rating).

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Defuzzification
We get the final credit score using defuzzification on the output fuzzy set by
Centroid method. Centroid defuzzification returns the center of area under
the curve. If you think of the area as a plate of equal density, the centroid is
the point along the x axis about which this shape would balance. The credit
score will lie in the range of 0-320.

Decision making: The number obtained from this model is a customers

credit score. It does not automatically decide whether someones loan will be
approved or not. However a good score will greatly enhance the odds of
getting the loan approved. Thw working of the credit score has already been
explained in Chapter 3.

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Fuzzy Inference System File Code
[System]
Name='btp'
Type='mamdani'
Version=2.0
NumInputs=7
NumOutputs=1
NumRules=172
AndMethod='min'
OrMethod='max'
ImpMethod='min'
AggMethod='sum'
DefuzzMethod='centroid'
[Input1]
Name='Debt_ratio'
Range=[0 50]
NumMFs=5
MF1='very_bad':'trapmf',[40
45 60 100]
MF2='bad':'trimf',[17 31 45]
MF3='normal':'trapmf',[10 17
19 25]
MF4='good':'trimf',[3 10 17]
MF5='very_good':'trapmf',[58.6 -9.32 4 10]
[Input2]
Name='loan-to-value_ratio'
Range=[0 150]
NumMFs=5
MF1='very_bad':'trapmf',[85
100 180 300]
MF2='bad':'trimf',[70 85
100]
MF3='normal':'trapmf',[50 65
75 85]
MF4='good':'trimf',[30 50
70]
MF5='very_good':'trapmf',[176 -27.9 29.9603174603175
50.6]
[Input3]
Name='Debt_coverage_ratio'
Range=[0 5]
NumMFs=5
MF1='very_bad':'trapmf',[5.865 -0.9325 1.2 1.25]
MF2='bad':'trimf',[1.1 1.25
1.4]
MF3='normal':'trapmf',[1.25
1.35 1.45 1.55]
MF4='good':'trimf',[1.4 1.75
2.05]
MF5='very_good':'trapmf',[1.
75 2.1 6 10]
[Input4]

Name='priority_sector +
prior bank customer'
Range=[0 5]
NumMFs=5
MF1='very_bad':'trapmf',[5.865 -0.9325 1 2]
MF2='bad':'trimf',[1 2 3]
MF3='normal':'trapmf',[2 2.5
3.5 4]
MF4='good':'trimf',[3.5 4
4.5]
MF5='very_good':'trapmf',[4
4.5 6 10]
[Input5]
Name='online_retail_default'
Range=[0 1]
NumMFs=5
MF1='very_bad':'trapmf',[0.5
0.6 1.1 1.9]
MF2='bad':'trimf',[0.3 0.45
0.6]
MF3='normal':'trapmf',[0.15
0.2 0.4 0.5]
MF4='good':'trimf',[0.08
0.15 0.3]
MF5='very_good':'trapmf',[0.36 -0.04 0.08 0.15]
[Input6]
Name='bill_payment_default'
Range=[0 1]
NumMFs=5
MF1='very_bad':'trapmf',[0.2
5 0.3 1.1 1.9]
MF2='bad':'trimf',[0.15 0.25
0.35]
MF3='normal':'trapmf',[0.075
0.1 0.2 0.25]
MF4='good':'trimf',[0.04
0.075 0.15]
MF5='very_good':'trapmf',[0.36 -0.04 0.05 0.1]
[Input7]
Name='bank_default'
Range=[0 1]
NumMFs=5
MF1='very_bad':'trapmf',[0.1
8 0.3 1.1 1.9]
MF2='bad':'trimf',[0.14 0.18
0.3]
MF3='normal':'trapmf',[0.08
0.11 0.15 0.18]
MF4='good':'trimf',[0.02
0.08 0.14]
MF5='very_good':'trapmf',[0.36 -0.04 0.04 0.08]

Page 27

[Output1]
Name='output1'
Range=[0 320]
NumMFs=16
MF1='D':'gauss2mf',[41.3 9.47 9.59 2.0564168656584]
MF2='C-':'gaussmf',[4.35
29.3731310942578]
MF3='C':'gaussmf',[4.76
49.4665222101842]
MF4='C+':'gaussmf',[4.072143
76489123 69.8]
MF5='Ca':'gaussmf',[4.32
87.7731310942579]
MF6='Caa':'gaussmf',[4.35
108.266522210184]
MF7='b-':'gaussmf',[3.93
127.879739978332]
MF8='b':'gaussmf',[4.17
147.919826652221]
MF9='b+':'gaussmf',[4.63
169.733477789816]
MF10='ba':'gaussmf',[4.87
190.320260021669]
MF11='baa':'gaussmf',[3.89
208.926868905742]
MF12='a-':'gaussmf',[5.42
227.466955579632]
MF13='a':'gaussmf',[4.591674
73828521 250]
MF14='a+':'gaussmf',[3.32183
282669534 270]
MF15='aa':'gaussmf',[4.99655
186951675 290]
MF16='Aaa':'gaussmf',[8
318.5]
[Rules]
1 1 1 1
3 3 3 3
5 5 5 5
2 2 2 2
4 4 4 4
2 2 2 2
2 2 2 2
2 2 2 2
2 2 2 2
2 2 2 3
2 2 2 3
2 2 2 3
2 2 2 3
2 2 3 3
2 2 3 3
2 2 3 3
2 2 3 3
2 3 2 3
2 3 3 2
2 3 3 3
2 3 3 3

1
3
5
2
4
2
3
3
3
2
3
3
3
2
3
3
3
3
3
2
3

1
3
5
2
4
3
2
3
3
3
2
3
3
3
2
3
3
3
3
3
2

1,
3,
5,
2,
4,
3,
3,
2,
3,
3,
3,
2,
3,
3,
3,
2,
3,
3,
3,
3,
3,

1 (1) : 1
11 (1) : 1
16 (1) : 1
6 (1) : 1
14 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1

2
3
3
3
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
2
2
2
2
2
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
5
4
4
4
4
4
3
3
3
3
3
3
3
3
3
3
3

3
2
3
3
1
1
1
1
1
1
1
1
1
1
1
1
1
2
2
2
2
2
1
2
2
2
2
5
5
5
5
5
5
5
5
5
5
5
5
5
4
4
4
4
4
5
4
4
4
4
3
3
3
3
3
4
4
4
4
4
4

3
3
2
3
1
1
1
1
1
1
1
1
2
2
2
2
2
1
2
2
2
2
2
1
2
2
2
5
5
5
5
5
5
5
5
4
4
4
4
4
5
4
4
4
4
4
5
4
4
4
4
4
4
4
4
3
4
4
4
4
4

3
3
3
2
1
1
1
1
2
2
2
2
1
2
2
2
2
2
1
2
2
2
2
2
1
2
2
5
5
5
5
4
4
4
4
5
4
4
4
4
4
5
4
4
4
4
4
5
4
4
3
4
4
4
4
4
3
4
4
4
4

3
3
3
3
1
2
2
2
1
2
2
2
2
1
2
2
2
2
2
1
2
2
2
2
2
1
2
5
4
4
4
5
4
4
4
4
5
4
4
4
4
4
5
4
4
4
4
4
5
4
4
3
4
4
4
4
4
3
4
4
4

3
3
3
3
2
1
2
2
2
1
2
2
2
2
1
2
2
2
2
2
1
2
2
2
2
2
1
4
5
4
4
4
5
4
4
4
4
5
4
4
4
4
4
5
4
4
4
4
4
5
4
4
3
4
4
4
4
4
3
4
4

2,
2,
2,
2,
2,
2,
1,
2,
2,
2,
1,
2,
2,
2,
2,
1,
2,
2,
2,
2,
2,
1,
1,
1,
1,
1,
1,
4,
4,
5,
4,
4,
4,
5,
4,
4,
4,
4,
5,
4,
4,
4,
4,
4,
5,
5,
5,
5,
5,
5,
4,
4,
4,
3,
4,
4,
4,
4,
4,
3,
4,

9 (1) : 1
9 (1) : 1
9 (1) : 1
9 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
4 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
15 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1

Page 28
4
4
4
4
4
4
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
4
4
4
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
2
2
3
3
3
3

3
4
4
4
4
4
3
3
3
3
3
3
3
3
3
3
3
3
4
4
4
3
4
4
3
3
3
3
3
3
3
3
3
3
3
3
2
2
2
3
2
3
2
2
2

4
3
4
4
4
4
3
3
3
3
3
3
3
3
3
4
4
4
3
4
4
4
3
4
3
3
3
3
3
3
3
3
3
2
2
2
3
2
2
2
3
2
3
2
2

4
4
3
4
4
4
3
3
3
3
3
3
4
4
4
3
4
4
4
3
4
4
4
3
3
3
3
3
3
3
2
2
2
3
2
2
2
3
2
2
2
2
2
3
2

4
4
4
3
4
4
3
3
3
4
4
4
3
4
4
4
3
4
4
4
3
3
3
3
3
3
3
2
2
2
3
2
2
2
3
2
2
2
3
3
3
2
2
2
3

4
4
4
4
3
4
3
4
4
3
4
4
4
3
4
4
4
3
3
3
3
3
3
3
3
2
2
3
2
2
2
3
2
2
2
3
3
3
3
3
3
2
2
2
2

4,
4,
4,
4,
4,
3,
4,
3,
4,
4,
3,
4,
4,
4,
3,
3,
3,
3,
3,
3,
3,
3,
3,
3,
2,
3,
2,
2,
3,
2,
2,
2,
3,
3,
3,
3,
3,
3,
3,
3,
3,
2,
2,
2,
2,

13 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1
13 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
12 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
10 (1) : 1
7 (1) : 1
7 (1) : 1
7 (1) : 1
7 (1) : 1

3
3
3
3
3
3
3
3
2
2
2
2
2
2
1
1
1
1
1
1
2
2
2
2
2
1
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2

2
2
2
3
3
3
3
3
3
2
2
2
2
2
1
1
1
1
1
2
1
2
2
2
2
2
1
2
2
2
2
2
1
1
1
1
1
2
2
2
2
2
2
2

2
2
2
3
2
2
2
2
2
3
2
2
2
2
1
1
1
1
2
1
1
1
1
1
2
2
2
1
2
2
2
2
1
1
1
1
2
1
1
1
2
2
2
2

2
2
2
2
3
2
2
2
2
2
3
2
2
2
1
1
1
2
1
1
1
1
1
1
1
2
2
2
1
2
2
2
1
1
1
2
1
1
1
2
1
1
1
2

2
2
2
2
2
3
2
2
2
2
2
3
2
2
1
1
2
1
1
1
1
1
1
1
1
2
2
2
2
1
2
2
1
1
2
1
1
1
2
1
1
1
2
1

3
2
2
2
2
2
3
2
2
2
2
2
3
2
1
2
1
1
1
1
1
1
1
2
1
2
2
2
2
2
1
2
1
2
1
1
1
2
1
1
1
2
1
1

2,
3,
2,
2,
2,
2,
2,
3,
2,
2,
2,
2,
2,
3,
2,
1,
1,
1,
1,
1,
1,
1,
2,
1,
1,
2,
2,
2,
2,
2,
2,
1,
2,
1,
1,
1,
1,
2,
1,
1,
2,
1,
1,
1,

7
7
7
8
8
8
8
8
8
8
8
8
8
8
2
2
2
2
2
2
2
2
2
2
2
5
5
5
5
5
5
5
3
3
3
3
3
3
3
3
3
3
3
3

(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)
(1)

:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:
:

1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1

Page 29

Chapter 4
Data and Results
Due to lack of real life data for all our inputs, we applied our data analysis on
5 individuals, with a created financial history.
1. Individual A- With a good business, A has assets worth Rs 10 crore a
debt of Rs 30 lakhs. He has been buying a lot of things from online stores
and is quite a reliable customer, having refused or rejected items that he
ordered only twice in 40 transactions. He also pays his DTH, mobile and
electricity bill regularly on time, with a late payment or default rate of
only 2.5%. He has never had a case of a bounced check or non-payment of
credit card dues and always pays his EMIs on time. He wants to take a
loan worth Rs 30 lakhs @ 14% interest rate from a bank to start a small
scale industry (which is a priority sector lending area as prescribed by
RBI). He has been a customer of that bank for the past 20 years. He is
ready to put up the property where he plans to open the industry and
which is worth Rs 1 crore as collateral for the loan. His annual income
comes out to be Rs 20 lakh. Based on this data, the 7 financial inputs of
our model for A comes out to be (0.03,0.30,3,5,0.05,0.025,0.05,313.932).
His credit score comes out to be 313.356 which is close to the best.
According to our model, the bank should definitely give him the loan.
2. Individual B- B wants to take a similar loan as A for the same purpose.
But he has inferior assets valued at Rs 1 crore and a debt of Rs 29 lakhs.
Also, he can only provide a property worth Rs 60 lakh as collateral. Like A
he also pays his bills regularly and he has the same annual income as A.
but due to the inferior debt ratio and loan to value ratio his credit score
comes out to be 218.4. The difference in score between A and B is a lot,
because of the increased risk the bank has to undergo. In case Bs
industry does not work, due to lower value of collateral and assets, it will
be really difficult for the bank to recover its investments. Hence, giving
loan to B is a more risky proposition but bank should still consider giving
him the loan because his other credentials are quite good.
3. Individual C- C has assets worth Rs 1 crore and outstanding debt of 19
lakhs. He is an occasional defaulter in bill payments (15%). Sometimes,
he has also been late in his credit card and other bank payments (10%).
Similarly he has also not paid up once in a while on Cash-On-Delivery
payments while ordering from online retail websites. He wants to take a
loan of Rs 7 lakhs to buy a car (not a priority sector). He has Gold worth
Rs 10 lakhs which he can give as collateral. He earns around 12 lakhs per
year. According to his financial data, his credit score comes out to be 160.
His is a borderline case. The bank or NBFC can decide to give him the loan
or not.

Page 30
4. Individual D- D has assets worth Rs 50 lakhs and a debt of Rs 22.5 Lakhs.
He has quite a high defaulting rate in all his payments, be it credit card,
online retail, mobile or electricity payments. His annual salary is Rs 10
lakhs. He wants to take a loan of Rs 9.50 lakhs as a housing loan (not a
priority sector). He has collateral worth Rs 10 lakhs to cover the loan. He
has been the customer of that bank for only 3 years. His credit score
comes out to be 39.8403. The bank should not give a loan to this
individual. There is a very high risk of his defaulting and he does not have
enough assets for the bank to recover its loan.

Individuals Debt Loan Debt

Priority
Online Bill
ratio to
Coverage Sector+prior retail
Payment
Value ratio
bank history default default
Ratio
1.A
0.03 0.30 3
5
0.05
0.025
2.B
0.29 0.50 3
5
0.05
0.025
3.C
0.19 0.70 1.4
1
0.1
0.15
4.D
0.45 0.95 1
1
0.5
0.75
5
0.19 0.70 1.4
2.5
0.3
0.15
6
0.30 0.85 1.25
1.5
0.45
0.25
7
0.03 0.30 3
5
0.15
0.075
Table 2: Credit Scores for different individuals

Bank
Credit
Default Score

0.05
0.05
0.1
0.3
0.1
0.175
0.1

313.356
218.4
160
39.8403
182.7180
124.4528
290

Page 31

Chapter 5
5 Conclusions
Fuzzy logic provides a natural means for handling the imprecise statements
and approxi-mate reasoning articulated by commercial lend-ing experts. In
summary, the application reported in this paper demonstrates how fuzzy
logic can be used to model the abilities of a commercial lending expert. Fuzzy
logic proves out to be much better than traditional approaches to calculate
the credit rating based on crisp value methods.[13]
The credit rating of an enterprise is frequently described as very good,
good, poor, very poor. It would be impossible to describe the rating as
good etc completely objectively. Although if large dataset is available, we
can make some good objective decisions. However the different grades
obtained with these objective results must constantly change with time, with
mindset etc. The fuzzy set represents linguistic or vague terms and hence it is
neither complex nor too simplified representation for the credit risk
evaluation. For such a subjective problem as loan assessment, fuzzy is one of
the most suitable mathematical model available.
In our analysis of an individuals credit worthiness, we have tried to take
advantage of the plethora of data available about an individual in todays
digital age. The online retail boom that India has seen in recent years,
provides us with real data about an individuals honesty and seriousness of
commitment when faced with paying a bill of a few hundred rupees. Similarly
with the advent of credit cards, debit cards, NEFTs, RTS, net banking, mobile
banking etc. banks also have a huge amount of digital data, pertaining to each
of their customers. Also, telecom companies, DTH TV companies, public
utility providers like BSNL, Power Grid etc are also gradually dealing with
online payments, automatically creating a record book of their customers
timely or untimely payments. It is RBIs intention to combine and consolidate

Page 32
these various sources and make a digital repository of individuals payment
history. Hence, in the future all these parameters could be used to calculate
the credit worthiness of an individual. In that scenario, our model would not
only be viable, but also has the potential to become the standard model used
by commercial banks for loan appraisal.
A lot needs to be done in the development of the model. It requires data
related to all the inputs, to make the membership functions more suitable
and attuned to the market. It also requires some aspects of machine learning
so as to deliver optimum results. All that requires further research.

Page 33

Bibliography
[1]

Kar A. , Stock Prediction using Artificial Neural Networks,

retrieved

April (2013) , Available FTP:

http://www.cs.berkeley.edu/~akar/EE671/report_stock.pdf
[2]

Novk, V., Perfilieva, I. and Moko, J. (1999) Mathematical

principles of fuzzy logic Dodrecht: Kluwer Academic

[3]

John O. Rawlings, Sastry G. Pantula and David A. Dickey,

Review of Simple Regression in Applied Regression Analysis:A
Research Tool, 2nd edition [Online] Available FTP:
http://web.nchu.edu.tw/~numerical/course992/ra/
Applied_Regression_Analysis_A_Research_Tool.pdf

[4]

Definition of Debt Ratio

[Online] Available FTP:

http://www.investopedia.com/terms/d/debtratio.asp
[5]

Debt Service Coverage Ratio (DSCR)

[Online] Available FTP:

http://www.efinancemanagement.com/financial-analysis/
debt- service[6]

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