20 September 2017
Jonathan Westley

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Jonathan Westley - Experian

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Age, economy and regulation: How a decade has changed the credit risk industry

28 April 2017  |  4328 views  |  0

Ten years ago, the Bank of England interest rate sat at 4.75% Now? Now it sits at the unhappily low rate of 0.25%. To put this in perspective, on a £150k mortgage over 25 years, today’s payment would be £516 a month. Ten years ago, the cost would have been £855. This equates to a 66% difference – presenting a considerable change which will affect the affordability of the consumer.

Losses need to be anticipated from businesses which don’t consider changes, such as a change in interest rate. These losses will be brought about by customers who are struggling to make their committed payments following an interest rate rise – or fall. New levels of disposable income do not equate to a fall in rates; during the length of a mortgage for example, rates will fluctuate which can cause an income squeeze at another point during the lifetime of the loan. Economic changes are expected, but people should be changing too.

Those who were celebrating their 21st birthday a decade ago are most likely to be recently married and planning their family – topped off with the recent purchase of their first home. Financially and personally, this brings a change of circumstance.

These examples highlight how the economy and the customer can change. And, while the example given shows the difference of 10 years, changes occur daily – influenced by economic change and personal circumstance. It’s important for leaders to identify and respond to changes in real-time. By doing this, it will enhance credit risk decisions and reduce losses. With so many factors to consider within a credit risk strategy, lenders need to assess what areas would give the most significant uplift in decision making.

Another factor to consider is how scorecards have changed in the last decade. Scorecards can be built to adapt. The more sophisticated models also include extra information about an individual’s finances and behaviours to give a complete picture that isn’t based on one denominator. You can incorporate additional layers of valuable customer information such as credit applications from multiple sectors including banking, finance, retail, telecommunications and short term lending, for example.

Scoring is now regarded as a tradition and creates a framework for organisations to assess an individual’s credit risk, in line with the credit strategy. However, it’s possible for scorecards to become less accurate over time. Regardless of how much data you feed into them, if the basic risk model isn’t reflective of the current point in time, it will return results that aren’t an accurate reflection on the customer. The less accurate scorecards are, the more the weighting of rejections and approvals can change too, impacting your operational teams with a need for manual underwriting in order to gain a true view of peoples’ financial status in order to reach a decision. More importantly, you could be accepting the wrong people which in turn could impact your bad debt, but also hinder financial inclusivity for those who were worthy of being accepted. Ultimately this means people aren’t being offered the right products for their needs.

An additional change comes in the form of regulation. The common denominator across all new and revised regulations is customer centricity. Organisations need to ensure at every point they are ‘treating customers fairly’ and appropriately, but the key aspect comes in knowing their customers. Being able to do this effectively requires a flexible business model that can adapt to changes in the economy, compliance and customer demands.

 Throwing yet another angle into the mix – consumers are becoming less risk averse themselves. In a recent survey, 1 in 10 told us they had applied for credit knowing they couldn’t afford it. Therefore, businesses need to ensure their rules reflect their business needs.

Operational efficiencies and customer engagement have been identified by two-thirds of organisations as core areas of business development. Therefore, with such a large scale problem to solve, having a burden such as inaccurate scoring is something businesses needn’t be hassled by – leaving time to focus on other areas of development.

For some, updating a scorecard may just necessitate a simple policy change, while for others, it is much more complicated as scoring is embedded into legacy systems and wider operational programmes. And it's often thought that more in-depth changes can be costly. However, with your risk strategy becoming better balanced, and your level of losses from accepting the wrong people reduced, the costs are likely to be recouped. 

Businesses need intelligent thinking; they need to consider what reward would emerge from enhanced application screening, new data feeds and a more comprehensive customer view, rather than simply considering the scorecard as a limiting factor for lending. You may accept less, but the likelihood of them unable to pay back the loan is reduced and the overall growth and financial return is enhanced.

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