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We developed a method for managing the characteristics of a bank's card holder portfolio in an optimal manner. The annual percentage rate (APR) and credit line of an account influence card use and bank profitability. Consumers find low APRs and high credit lines attractive. However, low APRs may reduce bank profitability, while indiscriminate increases in credit-lines increase the bank's exposure to credit loss. We designed the PORTICO (portfolio control and optimization) system using Markov decision processes (MDP) to select price points and credit lines for each card holder that maximize net present value (NPV) for the portfolio. PORTICO uses account-level historical information on purchases, payments, profitability, and delinquency risk to determine pricing and credit-line changes. In competitive benchmark tests over more than a year, the PORTICO model outperforms the bank's current method and may increase annual profits by over $75 million.
(Financial institutions: banks. Dynamic programming/optimal control: Markov, finite state.)
A retentive memory may be a good thing, but the ability to forget is the true token of greatness.
Elbert Hubbard (19th century philosopher, not necessarily speaking about MDPs)
Suppose you are considering a large purchase. You carry three credit cards with different pricing, spending limits, and terms. Which card will you use? Will the credit line or the annual percentage rate (APR) on the cards influence your decision? In industry parlance, which card will be at the "top of your wallet?" Intense competition in the banking and credit-card industry makes the answers to such questions extremely important. Credit issuers apply statistics and operations research to answer these questions. We applied modeling and optimization methods to the problem of awarding credit lines and changing APRs to customers.
Trends in the Credit-Card Industry
Credit cards have come a long way from their origin as charge cards, a convenient way of making payments (without the option of drawing on a revolving line of credit). The first credit-card banks arose in the early 1980s. There are now more than 7,000 US credit-card issuers and 27,000 types of credit cards (Hanft 2000). Today, consumers can use their lines of credit for various payment and personal-financing needs. On the merchant side, it is hard to find businesses that do not accept credit cards; even grocery stores and the Internal...