Abstract
In this article, Graham Lund looks at the challenges currently faced by
senior credit risk professionals and the role greater data use can play in all
aspects of the credit lifecycle.
He concludes that credit risk management is a complex discipline covering the
entire customer lifecycle.
The current challenges thrown up by the 'credit crunch', and subsequent events,
have put the credit strategies of most organisations under increased focus.
The greater use of external data, particularly in areas such as indebtedness
identification and collections, coupled with new tools such as daily alerts and
affordability measures, has the potential to equip credit risk professionals to
operate successfully in this dynamic landscape.
Those who lead the way by embracing these developments are the most likely to
succeed.
Introduction
Less than a year ago 'credit crunch' was a phrase very few people were aware
of. Yet after the events of the last few months it's a phrase that now appears
to be in daily circulation.
Technically a 'credit crunch' is a constriction in the supply and an increase in
the price of short term lending between institutions, but its impact has been
far more widespread than this definition would suggest.
What started out as a loss of confidence in the securitised products
underpinning US sub-prime mortgage debt soon spread to the UK.
The impacts of the crunch were felt most keenly felt by institutions which rely
on the short term money markets and securitisation to fund their lending.
At Northern Rock the pressure on funding and the media impact on customer
confidence led to a run on the bank, an occurrence few of us thought we would
ever see.
Annual bad debt losses run into the billions of pounds and the events of the
past few months have put this element of the results of most institutions under
an even more intense spotlight.
The increase in funding costs has put further pressure on profit margins. The
combination of these two factors makes the job of lending profitably to the
right customers even more crucial.
Given the uncertain market conditions, many institutions have been comfortable
to restrict lending over the past few months.
However the pressure will soon resume to grow lending and deliver the results
shareholders expect.
Credit Marketing
Acquiring new customers is often the first touch point a lender will have
with a consumer and can have a major impact on portfolio quality and
profitability.
Traditionally lenders were happy to 'target' large parts of the UK population in
a mass volume manner, hoping to maximise response rates and lending volumes.
The recent reduction in profit margins and the increased emphasis on good
quality lending is leading increasing numbers of organisations to be more
targeted in their activity.
The process of pre-screening potential customers for adverse data via a credit
reference agency (CRA) is now well established.
Increasing numbers of lenders are moving towards "dual wash" strategies with a
second bureau or indeed champion-challenging their existing supplier.
This approach ensures that lenders can access the most predictive data available
to them with clients finding an additional 20% of prospects who are ineligible
or uneconomic to mail, resulting in reduced costs and a better overall customer
experience.
The use of multiple agencies also encourages creative thinking, product
innovation and healthy commercial rivalry.
Application Processing
Whether it is a completely new relationship or an existing customer
requesting additional facilities this process has historically been heavily
based around credit bureau data integrated into a lender's front-end scoring
system to arrive at an accept/decline decision.
The business impact of account origination puts a significant onus on credit
risk professionals to optimise the risk/reward balance not just by accepting the
right customers but by pricing them appropriately.
Against a back drop of overindebtedness, it is worth noting that more and more
lenders are finding their traditional methods of credit scoring are missing, or
at least not effectively identifying, a sub-set of the population that is
becoming or are already highly overindebted.
This vital missing element is the affordability of the debt to individual
customers.
Lenders are increasingly using new tools and strategies to identify customers
with high levels of unsecured debt with what would traditionally be considered
'good' credit risk profiles (i.e. they are up to date with their credit
commitments).
In extreme cases of indebtedness, where the ratio of unsecured debt to net
monthly income is in excess of 25 to 1, it can be seen that more than 50% of
consumers are up to date on their credit facilities with multiple lenders and
75% have been no more than 1 payment down on any product in the last 12 months.
Recent analysis has shown that a number of overindebted customers have improved
their position by accessing the equity in their property via a remortgage or
second charge mortgage.
Given the tightening in lending criteria following the 'credit crunch' it may be
difficult for customers to restructure their debt in the same way in 2008.
The challenge is integrating this new approach into existing credit strategies.
It is clear that it is not a direct replacement for traditional scorecards,
rather that indebtedness data should work in tandem with credit risk scores to
deliver optimised credit decisions.
Unsurprisingly, many lenders are working on developing multi-bureau strategies,
not only to maximise the use of 'similar' data from multiple CRA's but also to
integrate predictive variables based on indebtedness data and adopting tools
that measure the affordability of additional lending for a customer.
Customer Management
The changing economic landscape, increasing utility prices and customers
rolling off low rates fixed mortgage deals makes the on-going risk assessment at
customer level essential.
Many lenders operate behavioural scoring systems with the majority underpinned
by monthly bureau data feeds either from one or multiple CRAs.
The credit strategy within these systems is complex, often made up of numerous
scoring models and distinct credit strategies covering a variety of products,
brands, segments and business processes.
Whether it is shadow limits on credit cards, auto-pay limits on current accounts
or customer level risk indicators, the number of parameters that require
maintenance and monitoring is significant.
The speed with which organisations react to changes in customer behaviour is
crucial to successfully managing lending portfolios.
The recent introduction of daily monitoring and alert services offers the
ability to react more dynamically to changes in customer behaviour than possible
with traditional monthly scoring runs.
Integrating this data into existing credit strategies can be complex but is
certainly achievable in timescales that ensure benefits are realised and a
competitive edge gained.
Collections & Recovery
Historically this area has been less developed in relative terms and in some
respects this is an opportunity. Many collections systems still tend to be
operationally focused with contact strategies driven by balance rather than risk
or probability of repayment.
Recent innovations in this area are numerous. Institutions are adopting
pre-delinquency management techniques to establish dialogue with customers
before they have missed any payments and advanced multi-stage statistical
modelling is now being deployed to predict the propensity to repay.
Lenders are also starting to utilise tools which look at customer affordability
as part of collections negotiation activity, with income data being used to
identify customers who may be understating their ability to repay delinquent
debts.
The debt sale arena is growing as institutions look to sell on debt and release
the regulatory capital it ties up, both sellers and buyers are benefitting from
much greater use of CRA data and are deploying tracing and segmentation tools to
improve performance.
Taking these developments as a whole it becomes clear that the use of data in
Collections and Recoveries is increasingly adding value to the bottom line of
many organisations.
Summary
In summary, credit risk management is a complex discipline covering the entire
customer life cycle.
The current challenges thrown up by the 'credit crunch', and subsequent events,
have put the credit strategies of most organisations under increased focus.
The greater use of external data, particularly in areas such as indebtedness
identification and collections, coupled with new tools such as daily alerts and
affordability measures, has the potential to equip credit risk professionals to
operate successfully in this dynamic landscape.
Those who lead the way by embracing these developments are the most likely to
succeed.
Graham Lund is Deputy
Managing Director of Callcredit
Source:
Credit Control Journal
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