Risk is changing. Are you ready for the opportunities and challenges?
Businesses in the UK and around the world are facing a whole new range of potential risks, both in the short and long-term. As we currently navigate our way through the challenges that the COVID-19 outbreak has brought, we’re exposed to increasing numbers of new and evolving risks. Understanding them and knowing how to juggle risk versus reward won’t just protect businesses, it will also open doors to prospective new customers, new products and services, and new ways of working.
Find out more about risk management in a new decade and a rapidly changing world in our in-depth guide – including how you could benefit.
What is risk management
Risk is a part of everyday life and the same is true for risk in organisations. Pretty much every aspect of business contains risk. Every decision you make holds risk. The key is knowing how to do business in a way that protects you and allows you to manage business risk successfully.
What are the seven key risks for businesses?
Traditionally, business risks have fallen into a number of key categories, covering different aspects of business management. Each risk will mean something different to individual businesses, so it’s important to identify, analyse and mitigate risk bespoke to your organisation. It’s also vital to understand how these risks evolve over time, interconnect and impact one another. The risks can be shaped by the local, national and global environment that the businesses are operating in.
- Physical risk
Physical risks include dangers that pose a threat to physical assets, including your buildings, equipment and people. Risks could be events such as fire, flooding, or crimes like theft and vandalism. Physical damage can present a risk to your business in a number of ways, from time lost and repair costs, to legal action and reputational harm if you’ve failed to guard against the risks appropriately.
- Strategic risk
How do you know you’ve made the right decision for your business? Decision making often involves balancing risk versus reward. On the one hand, the right decision could help you achieve your business goals, on the other, a wrong move could negatively impact your organisation. Plus of course, it’s not just down to the decision itself, but also the way it’s executed. A poor strategy can result in multiple challenges, from low sales and poor profits to dissatisfied customers and reputational harm.
- Compliance (Regulatory) risk
Businesses are governed and guided by a wealth of legislation, regulation and responsibilities, both mandatory and voluntary. Some will be unique to your organisation, industry or sector, others will be more generic across business, such as health and safety and data protection law. The risks of failure to be compliant can be severe, including legal action, fines, penalties and even closure. Beyond that, failing to fulfil your responsibilities is likely to damage your reputation. In terms of rewards, compliance is a chance to show your customers how you’re caring for their interests and improving how things are done.
- Operational (Human) risk
Operational risks involve the day-to-day running of your organisation, from human error or inappropriate staff behaviour, to systems failure, fraud and embezzlement. Anything that puts a spanner in your internal works, is likely to have a knock-on impact on your business, potentially resulting in lost time and revenue and even reputational damage. It’s important to remember that staff behaviour can impact your business anytime, outside work and in, both positively and negatively.
- Technology (Cybersecurity) risk
Doing business in an increasingly digital world naturally comes with both risks and rewards. Cyber-attacks and the reputational damage a data breach can cause are a growing concern for many businesses. On the plus side, data enriched by the in-depth understanding of artificial intelligence (AI) is helping businesses reach and connect with their customers like never before and develop new products and services. Technology risks can also be linked to events like loss of power, taking systems and equipment out of action, with many organisations choosing to generate their own power onsite.
- Financial risk
Financial risk is a good example of the external pressures’ businesses can face. From economic uncertainties and volatile financial markets, to the move towards sustainable finance with investors increasingly taking environmental and social factors into account. All of these things can impact an organisation financially, along with risks such as poor financial planning and projection and fraudulent activity. It’s also essential to consider the part wider socio-economic risks play in customer-related credit risks such as late or non-payment. Financial risks can result in loss of income and negative cash flow, and even bankruptcy if they’re not managed properly.
- Reputational risk
Reputational damage is often a consequence of poorly managed business risks, from failing to meet your responsibilities to making a misjudged decision. In a world where news and opinions can be shared instantaneously via social media and organisations are often seen through the prism of wider issues such as climate change and gender equality, it’s more essential than ever to understand reputational risk and how to protect yourself. Equally, it’s also important to recognise the potential of good risk management to enhance your reputation, with customers increasingly valuing honesty, transparency and positive action around the issues they care about.
What is credit risk management. And why it’s an essential part of financial risk management.
Offering credit to your customers can often be a vital way to secure and retain their custom, drive sales and boost your income over time, whether they can’t afford to pay full price for your product or service straight away or simply want to spread the cost. But how can you be sure your customers, including consumers and businesses, can and will repay you in full, on time?
Credit risk management
The most important factor to determine when offering credit is the balance between your risk and your reward. The more credit you give, the more you have to gain in sales, revenue and profit. However, your risk of loss, reduced profit and even bankruptcy also grows (especially for smaller businesses). How do you mitigate this risk and tip the balance in your favour?
How Experian can help
Credit risk management is all about making confident, responsible credit decisions that benefit everyone. By understanding credit risk, we can help you better understand your customers, automate complex decisions, improve customer experience and stay compliant, while helping you plan for and manage business and market changes.
Our insight allows you to:
- Understand customers’ behaviour and represent them better.
- Make informed decisions leading to responsible and profitable lending.
- Verify identity and prevent fraud.
- Fulfil regulatory obligations.
- Solve different problems in new and adjacent markets.
We have tools to help you analyse and minimise risk and enhance both consumer and commercial credit risk management, so that you can concentrate on creating new opportunities when offering solutions to businesses.
Credit risk management in 2020
As we head into a new decade, it’s important to understand how credit risk is changing as the world around us transforms, and how this is revolutionising risk management in many areas.
Identifying relevant risks and planning for them in advance, is the best way to mitigate risk and protect your business. It will also help you balance risk versus opportunity and open the door to potential benefits.
Three things your business can do right now
- Assess your organisation’s view of your customers. What information could help you to get a more complete view of your client base?
- What information does your business share with other organisations? If you share data with other providers, it could help people get improved access to services.
- Which groups are you under-serving? Whether groups of people are not on your organisation’s radar at all, or currently marginally declined, new data sources could be the answer to making better decisions and improving credit risk management.
Assessing affordability and managing risk
In the past, lending decisions have generally focused around the issue of credit risk, which really means: ‘If you’re doing okay with the credit you have today, let’s give you a bit more and see how you cope with that’.
Today, there’s a lot more focus on affordability, a person’s ability to pay, rather than willingness to pay. But how do you assess affordability when income isn’t predictive of credit risk in its own right, people tend to be overly optimistic about their financial future, and there’s no reliable way to determine disposable income?
Experian estimates income from different sources including previous credit applications, current account turnover (CATO) data and our bureau models, so you can verify a person’s income and compare it to the information they’ve given you, to make sure it’s consistent.
Although only banks can share CATO data, other organisations can still benefit from it through something called the CATO warning flag. This compares the income provided on the application form against the CATO estimate and returns a ‘flag’ to indicate that the income has been verified, is close to, or significantly different from, the CATO estimate.
Many lenders also look at the household’s total income, as well as the income of the main applicant.
Calculating disposable income
Once you’ve qualified a person’s income, you can then calculate disposable income and assess affordability, including identifying their level of indebtedness. For example, Experian’s Consumer Indebtedness Index (CII) can help you pinpoint individuals who are up-to-date with their credit repayments at the moment, but who, as a result of their levels of indebtedness, are likely to experience payment problems in the future.
We also make allowances for salary sacrifices such as pension contributions, to make sure disposable income is as accurate as possible.
Balancing risk versus reward with debt-to-income ratios
Using both income and disposable income, we’re able to provide debt-to-income ratios which look at total borrowing as a proportion of net or gross monthly income or disposable income. These ratios can then be included in your risk management process, as part of both risk analysis and affordability assessments, helping you juggle risk versus reward.
Our data and insight can help you make confident decisions, so you can assess affordability quickly and easily.
How are changing demographics affecting risk management?
How can businesses adapt and respond to the needs of our very different demographic groups, now and in the coming years, and what impact will that have on their approach to financial risk management?
New-school lending for old-school customers
People are now regularly living into their 80s and 90s and working beyond retirement, often in flexible and part-time jobs – which means confidence in lending to this previously untapped part of the market is beginning to grow.
Traditionally, credit providers only lent up to retirement age but many organisations are now creating specialised products and services aimed at The Ageing Population, such as mortgages for people aged up to 75.
In fact, of all the customer groups in the economy, the senior cohort could well see the biggest changes in the coming years. In light of this, credit providers should assess how this extended but changed working life could affect someone’s levels of risk and affordability, alongside the buoyant savings associated with older age groups.
An uncertain future
By the time Millennials start to retire, the economy could have changed significantly. As well as a volatile global economy and the impacts of climate change, Millennials are more likely to feel the as-yet-unknown effects of Brexit and COVID-19 on the UK economy and jobs, as well an ever-more-unaffordable housing market and changing interest rates.
On the upside, Millennials have a possible lending period of 40+ years, especially with credit providers already lending to people for longer, over which they could borrow and settle loans and mortgages.
Given how different things could be in the coming decades, organisations should be exploring how to build credit models that are flexible to both changes over time and fluctuating personal circumstances. That will also mean taking a fresh look at credit risk management, from risk analysis to risk mitigation.
Millennials and Generation Z are rightly referred to as ‘the future customer’ but The Ageing Population are likely to be future customers as well – needing different services provided in different ways.
More than ever, economic changes are likely to affect older and younger consumers in very different ways, so it’s vital that lenders take that into account when assessing affordability and developing risk strategies for different customer segments.
The eroding generation gap
Final salary pensions, high house price inflation and periods of economic growth have all worked in favour of the older age group, leaving them with substantial assets and property. In contrast, those currently in their 20s and early 30s are faced with high house prices, low wage growth, student loan repayments and the rising cost of renting and everyday living.
This disparity could well have an even bigger impact in the future. Many of today’s young adults have been able to turn to the Bank of Mum and Dad (BoMaD), which is now the 11th largest mortgage lender in the UK, supporting one in five property transactions in 2019.
Factor in higher life expectancy, rising care costs and the changing risks facing Millennials and Centennials, and it’s unlikely they’ll be able to keep the BoMaD open for their own children.
The changing consumer landscape could mean fewer mortgages are needed, fewer retired people will release housing equity and those nearing retirement will have less to spend on holidays and leisure.
By being aware of these trends, you can plan for the changes by creating products and services for the people most likely to need and afford them, alongside a robust, relevant risk management process. You can also help people make better financial choices now and be better prepared for the future.
The changing economy – demographic versus economic
The changing population isn’t the only challenge that businesses are likely to face in the coming decade. The current global pandemic, digitisation, climate change, and a changing socio-economic landscape could all have a profound impact on job creation, incomes and people’s working lives. And in turn, that will affect how organisations approach affordability and risk, resulting in new approaches to credit risk management.
Mitigating risk over time
Measuring a customer’s affordability, using robust processes and the most accurate data on their financial commitments, will ensure that your customers can not only pay you back at the start of the loan, but in the future. This alternative risk analysis will help you prevent and protect any losses, and better support your customers before they struggle.
As well as verifying income and calculating disposable income, a typical affordability assessment should also assess a customer’s ability to repay both today and over the lifetime of the commitment. From here, you can set affordable limits and assess both indebtedness and risk.
Whilst Open Banking APIs present an opportunity to personalise the risk management process at a much more granular level, economic foresight can give you a more enhanced, forward-looking view. Giving you a much longer-term, stabilised lending criteria to build from.
Risk versus reward
As the changing world of risk impacts on a changing population, there will be rewards out there for organisations keen to juggle risk versus opportunity. The trick will be knowing how change impacts people differently and which factors will be critical in decision-making and credit management.
Inclusivity and support
Customers are likely to need more advice and support in changing times, from older customers living and working longer, to younger customers facing a more uncertain financial future.
With the younger generation increasingly looking to alternative financial providers and sources of financial support, organisations are in a prime position to help champion responsible financial inclusivity, especially if they’re already seen as a trustworthy brand.
Our data and insight can help you make confident decisions, so you can assess affordability quickly and easily.
Risk management in 2020 – steps you can take to balance risk versus reward
- Be prepared
The world is changing fast and you’ll need to keep a close eye on interconnected socio-economic risks, including demographic changes, both in the UK and further afield.
Businesses in the UK are already dealing with the challenges posed by these global risks, as well as exploring the opportunities they present. During the current challenging trading conditions caused by COVID-19, the ability to adapt to evolving markets at speed and scale to disruption, while protecting customers, assets and reputation, is already separating top-performing firms from competitors.
- Be personal
As the UK continues to evolve, demographically, economically and socially, your customers will increasingly need and want products and services tailored to them. Strategically, that means you’ll need to understand your customers like never before, as well as the changes that will shape their lives.
Technology and compliance risks are likely to become more complex as data and the deep learning provided by artificial intelligence (AI) increasingly drives decision-making, but personalisation will also bring huge rewards.
- Be inclusive
Customers will look to trusted organisations for information and support to make the right decisions throughout their lifetime. For example, the financial sector is changing as younger customers look to alternative providers and initiatives like Open Banking make an impact.
Using new sources of data to strengthen and personalise credit risk analysis will help businesses find new customers. In the long-term, focusing on affordability and financial inclusion will also help organisations serve and support customers throughout their lifetime, selling not just a product or service, but making a genuine connection and building a real relationship.
Risk management planning
Here’s a five-step plan for establishing a comprehensive Risk Management Plan and understanding the Risk Management Process – from identifying risk to mitigating the impact.
Step 1: Identify potential risks
Spend time identifying the specific risks relevant to your business. Some risks may be business-wide, while others may only apply to certain sectors or demographics. Involve key stakeholders to ensure every aspect is covered.
Step 2: Conduct a risk analysis
Once you’ve identified your business risks, you’ll need to analyse their potential impact and likelihood of occurring. This will help you classify and prioritise risks when it comes to developing a risk management strategy and risk mitigation measures.
Step 3: Identify warning signs & agree Key Risk Indicators
A key part of preventing risks from occurring is being able to spot when they’re about to happen. Identify any triggers or warning signs for each risk and ensure they’re clearly documented and embedded into relevant processes. At this point, you should also agree your risk tolerance levels and risk targets to define the maximum and optimal level of risk you want to take before taking action.
Step 4: Identify preventative measures
Using your Risk Analysis and your Key Risk Indicators, you can now plan how and when you’ll put preventative measures in place to mitigate risk, based on your risk targets and risk tolerance levels.
Step 5: Assign responsibility
Each risk you’ve identified should be assigned a relevant owner, usually someone with the skills, experience and knowledge to understand the risk. This could also involve working with partners like Experian to upskill and support your in-house team. Owners are responsible for maintaining records and analysis, regularly reviewing risk, priority and actions, and making sure any actions agreed are carried out.