Though credit scoring for small-business loans has ballooned, questions persist about the new technology's discipline and its ability to withstand a recession.

In the last two years, almost all leading small-business lenders adopted credit scoring to reduce the time spent reviewing loan applications from an average of 12 hours to as little as 25 minutes.

Yet despite the unparalleled success in efficiency, bankers and regulators are still struggling to assess the risk of relying on the new technology.

"The true test will be to see how the loans perform in a economic downturn," said Carmen G. Mastroianni, Chase Manhattan Corp. senior vice- president for small business lending.

Scott Calhoun, the deputy comptroller for risk evaluation for Office of the Comptroller of the Currency, said the agency is watching credit scoring closely.

While the OCC has no set policy on credit scoring, Mr. Calhoun said the agency is debating whether guidelines are necessary to ensure the new technology can withstand changes in the banking environment.

"We want to make sure it stays reasonable and the banks have the knowledge and background to use it properly," Mr. Calhoun said.

Mr. Calhoun said the OCC looks at how the credit scorecard was mathematically designed, whether the loan performance data includes information from a recession and how banks monitor loan portfolios made up of scored credits.

Credit scoring provides a computerized formula that mathematically evaluates a business' finances and the owner's personal credit history to boil credit risk down to a single number.

Traditionally, lenders asked small-business loan applicants directly for tax returns and other financial information to individually determine the loan risk.

But credit scoring programs already have this information - some drawn from huge existing data bases of business information - and plug in the numbers to come up with a score.

Even lenders at Chase, which was part of a pilot group of lenders who began using a Fair, Issac & Co. credit scoring system in June 1995, say the technology has not been tested.

Chase automatically approves the top 10% of the loans that score highly and automatically rejects the bottom 10%. Lenders still review the middle 80% individually.

For the most efficient use of credit scoring, Fair, Issac recommends that banks review no more than 20% of its loan applications individually.

More than 250 small business lenders use the Fair, Issac system, which was designed with information compiled from the small business portfolios of 17 banks.

Bankers, such as those at Chase, say they turned to Fair, Issac because they did not have a large enough loan portfolio or enough data to create their own statistically valid scorecard.

So far only four banks - Wells Fargo & Co., BankAmerica, Citicorp, and NationsBank Corp. - have created their own. But those four have been among the most aggressive in expanding their small-business loan portfolios.

Micheal Stoudt, Bank of America senior vice president for the business banking division, said custom designed scorecards can offer better results.

"Over the long haul you get much more predictability by using information from your own customers because they represent who you will lend to," Mr. Stoudt said.

BankAmerica's system bases its assessment of risk on historical information from more than 15,000 good loans and 15,000 bad loans. The bank uses it for loans up to $50,000.

"Lending is a risk business," Mr. Stoudt said. "What credit scoring does is help you quantify what the risk will be in the future."

For the other banks, Fair, Issac offers 13 scorecards, which can be customized for any bank's lending standards, to assess the loan risk.

But the credit score assessment is only as good as the data it's based on and the underlying assumptions about which statistics best predict a borrower's ability to repay a loan.

Only half the Fair, Issac scorecards use a business' financial information to gauge loan risk and those use only the information the business owners provide on the loan application.

The San Rafael, Calif.-based company found that the business owner's personal credit history, rather than the business' financial information, provide the best indication of loan risk, said Latimer Asch, Fair, Issac vice president of commercial products.

Some banks request financial information, such as tax returns, in addition to information obtained by phone or mail loan applications. But other banks do not.

The Fair, Issac software does not verify the financial information a business provides, but conducts a "reasonability check" to compare a loan applicant with similar businesses.

"The only assurance we have is that the business owner is being honest," Mr. Asch said. "You would lose out on all the efficiency if you did a detailed check of financial information."

While the OCC is not worried about the risk of inaccurate loan applications, Mr. Calhoun said the agency is concerned that information requested adequately reflects loan risk.

"It's one thing to model for individual behavior, it becomes much more complex and difficult to model for corporate behavior," Mr. Calhoun said.

First Union Corp., which uses a customized Fair, Issac scorecard for loans up to $250,000, scrutinizes larger loans more closely than small ones.

"Credit scoring gives us a good indication," said Martha Hayes, First Union Corp.'s director of small-business banking. "With larger dollar amounts, we look at the other factors more."

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