The differences a decade makes to credit risk

Alastair LuffThe Bank of England interest rate sits today at 0.25%. Ten years ago it was 4.75%. To put this in perspective on a £150k mortgage over 25 years, today’s payment would be £516 a month. 10 years ago, the cost would have been £855. This is a 66% difference which presents a significant change. A change like this will affect the affordability of the consumer. Businesses who don’t consider change – for example a change in interest rate, are likely to be faced with losses – brought by customers who are struggling to make their committed payments following an interest rate rise – or fall.

A fall in rates doesn’t mean the customer has a new found level of disposable income. With a mortgage for example, can span anything up to 35 years. During that time they will fluctuate which could cause an income squeeze at another point during the lifetime of the loan.

In addition to economic changes, people have changed 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. This brings a change of circumstance for them both personally and financially.

These examples highlight how the economy and the customer can change. And, whilst the example given shows the difference of 10 years, changes occur daily – influenced by economic change and personal circumstance. Lenders in particular need to be able 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 such as banking, finance, retail, telecommunications and short term lending for exampleHow can scorecards enhance business efficiencies?

Scoring now regarded as a tradition and creates a framework for organisations to assess an individual’s credit risk, in line with the credit strategy.

Over time, scorecards can become less accurate. 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. As scorecards become less accurate the weighting of rejections and approvals change too – this can impact your operational teams with a need for manual underwriting in order to gain a true view of persons 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.

At the same time as economic and customer changes, regulation is changing too. 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. They also need to ‘Know the Customer’. Being able to do this effectively requires a flexible business model that can adapt to changes in the economy, compliance and customer demands.

Throwing 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 ensuring your rules reflect your business needs is essential.

Two-thirds of organisations have identified operational efficiencies and customer engagement 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 can require a simple policy change, for others it is much more complicated as scoring is embedded into legacy systems and wider operational programmes. Perception when it does involve much more in-depth change can appear costly. However, the costs are likely to be recouped as your risk strategy is better balanced and your level of losses from accepting the wrong people is reduced.

Rather than considering the score you outline as a limiting factor for lending, businesses would be wise to consider what reward could be redeemed from enhanced application screening, new data feeds and a more comprehensive customer view. 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.