Loan default prediction using decision trees and random forest: A comparative study

Abstract

With the improving banking sector in recent times and the increasing trend of taking loans, a large population applies for bank loans. But one of the major problem banking sectors face in this ever-changing economy is the increasing rate of loan defaults, and the banking authorities are finding it more difficult to correctly assess loan requests and tackle the risks of people defaulting on loans. The two most critical questions in the banking industry are (i) How risky is the borrower? and (ii) Given the borrower’s risk, should we lend him/her? In light of the given problems, this paper proposes two machine learning models to predict whether an individual should be given a loan by assessing certain attributes and therefore help the banking authorities by easing their process of selecting suitable people from a given list of candidates who applied for a loan. This paper does a comprehensive and comparative analysis between two algorithms (i) Random Forest, and (ii) Decision Trees. Both the algorithms have been used on the same dataset and the conclusions have been made with results showing that the Random Forest algorithm outperformed the Decision Tree algorithm with much higher accuracy.