Working Paper

One Threshold Doesn’t Fit All: Tailoring Machine Learning Predictions of Consumer Default for Lower-Income Areas

Abstract: Modeling advances create credit scores that predict default better overall, but raise concerns about their effect on protected groups. Focusing on low- and moderate-income (LMI) areas, we use an approach from the Fairness in Machine Learning literature — fairness constraints via group-specific prediction thresholds — and show that gaps in true positive rates (% of non-defaulters identified by the model as such) can be significantly reduced if separate thresholds can be chosen for non-LMI and LMI tracts. However, the reduction isn’t free as more defaulters are classified as good risks, potentially affecting both consumers’ welfare and lenders’ profits. The trade-offs become more favorable if the introduction of fairness constraints is paired with the introduction of more sophisticated models, suggesting a way forward. Overall, our results highlight the potential benefits of explicitly considering sensitive attributes in the design of loan approval policies and the potential benefits of output-based approaches to fairness in lending.

Keywords: Credit Scores; Group Disparities; Machine Learning; Fairness;

JEL Classification: G51; C38; C53;

https://doi.org/10.21799/frbp.wp.2022.39

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2022-11-21

Number: 22-39