As the United States experienced the deepest recession in five decades, banking institutions are responding by scaling back on lending,  applying credit card rate changes, and cutting back on the available credit limit of their customers. The quarterly survey from the Federal Reserve (released May 4, 2009) revealed that 65% of all banks have decreased the credit limit available to new and existing credit card holders. Aside from the obvious fact that consumers cannot borrow as much as they used to, what is the implication of these developments on their FICO score?

Take the experience of Sharii Rey who works as a paralegal in Oregon. Her credit limit was drastically cut from $42,500 to $12,000 by JPMorgan Chase & Co. The lower amount of available funds is the least of her problems though. This is because her debt relative to funds available to her quadrupled and this will reflect badly on her FICO score. It will essentially crush her ability to borrow especially if she has a high outstanding balance.

According to an Illinois Democrat Luis Gutierrez, the FICO formula has a lot of loopholes because it lowers the consumer’s rating no matter their individual risk profiles if banks decrease the available amount of loans. In the second half of 2008, 30 million Americans had their credit limits decreased. This is because three of the country’s largest bank – Citigroup Inc., JPMorgan, and Bank of America Corp. had cut a total $320 billion from the consumer’s credit lines.

The economic collapse raised doubts on the validity of credit scores. Around 90 percent of US banks still use the FICO score to gauge the customer’s credit worthiness. However, the FICO scoring system, which was developed in 1956, seems inappropriate in today’s turbulent times. Still, the FICO CEO Mark Greene said that “FICO scores have held up quite well in terms of predictive accuracy”. And that the score change because of the banks’ actions may just be a signal that the environment is riskier thus, those who had their ratings cut have become “riskier consumers”.