Our Founder and CEO, Aneesh Varma, shares his opinion with Credit Management on the unique set of circumstances lenders now face today.
Over the last few weeks, we’ve seen the UK Chancellor unveil unprecedented measures to help businesses and homeowners cope with the financial impact of COVID-19. He said governments had never faced such a severe economic challenge during peacetime.
Rishi Sunak’s words were, no doubt, chosen carefully. With the effects of the global financial crisis of 2008 still keenly felt in many communities, they were also chilling.
When the 2008 crisis began, I worked at J.P. Morgan, advising consumer finance and fintech firms on mergers, acquisitions, and stock market flotations. Today, I lead Aire — a new type of credit bureau. We make credit work for everyone by leveraging consumers’ ability to share the precise circumstances that make up their financial pictures.
It is a position that offers unique insight into the challenges lenders face today — and how they compare to those of a decade ago.
Consumer lending levels to fall sharply
While lenders are in a better position today to keep consumer credit flowing, the volume and value of new consumer credit agreements will inevitably fall, as borrowers protect their finances, and lenders try to get a handle on future default rates.
Lenders will still need to write new credit lines to make money, but there will be great caution about what gets written. Lenders will sharpen their ranges. Those that provided credit to near-prime borrowers will look to prime consumers, while prime lenders will reach for super-prime customers.
Consumers who already find themselves at the margins of mainstream lending — such as recent migrants, gig workers and the self-employed — will find it even harder to get low-cost financial services — which is exactly the opposite of what consumers, the Financial Conduct Authority and the Financial Inclusion Commission want. These are also some of the people we expect will need credit most, to help overcome the cash-flow challenges of the coming months.
We expect that the rate of consumer-lending growth, which has been declining since 2016, could go negative by the middle of this year.
Lenders must do everything they can to keep low-cost, mainstream consumer credit flowing.
Financial stress will increase across society
Although the UK government has made significant commitments as it attempts to limit coronavirus-related job losses, it is clear consumers are going to experience a great deal of pain over the coming months.
The crisis will test the limits of lenders’ ability to understand what is happening in their loan portfolios, and their ability to support customers experiencing difficulties.
Redundancy and relationship breakdowns are the most common reasons why people end up in collections. Both increased around the time of the global financial crisis; we can only assume the same will happen now.
The Chartered Institute of Personnel and Development said that 1.3 million people were made redundant during the recession of 2008 and 2009. Few groups in society were immune from impact. The same can be expected now.
Lenders can expect to see default rates increase dramatically throughout 2020 and possibly well into next year too. Aire estimates that the number of people in the UK missing one or more credit payments could increase from around 700,000 last year to over 2 million this year.
A quarter of the workforce in the UK are employed in sectors where demand fell dramatically following government instructions to avoid social contact. Employers have let people go in large numbers in sectors such as hospitality, travel, leisure, retail, arts and entertainment. Many of those already affected are young people working for minimum wage.
We can expect many of the UK’s 5.8 million self-employed, freelancers and full-time gig workers to be hit soon after. After that, the pain could be felt far and wide.
Levels of personal insolvency are a retrospective indicator of financial distress. When they peaked in 2009 and 2010 following the last crisis, reaching levels four times higher than the long-term average, they were most frequent among the most disadvantaged groups in society.
The most significant increases, however, were among middle-income families, people who would typically occupy city-centre office jobs or earn good wages on the shop floor of large manufacturing plants. If history is anything to go by, the pain will be shared and felt for years.
What next for consumer lenders?
Faced with troubling economic conditions, credit providers need to take stock of their lending criteria, comprehend what is happening within their portfolios, and ensure they can make decisions based on the most up-to-date view possible of the consumer.
More cautious lending decisions may be one way to respond. However, this would need great care. The majority of consumers are still stable, low-risk borrowers and The Financial Conduct Authority (FCA) will be watching to ensure credit decisions are fair to the consumer.
A lesson from the last financial crisis was that historical credit data showing consumers’ previous propensity to pay was not, on its own, sufficient to make the most accurate lending decisions. Many people with spotless credit records ended up in collections through no fault of their own.
Affordability checks, which are now compulsory, have gone some way to making lending decisions equitable without being reckless. However, they can also be a blunt instrument. Generalised affordability measures still use historical information, and many lenders cannot work out precise disposable income levels, mainly because their scoring policies look at modelled data rather than the exact personal circumstances of the applicant.
None of these measures are dynamic enough to keep up with the real-time needs of today’s fast-changing economic environment. Lenders must be bold enough to back the right borrowers, and sufficiently agile and well informed to provide the proper support at the right time should they encounter problems.
The need for real-time, validated insight
New data sources, such as first-party data gathered from the consumer can be used to give lenders the most up-to-date picture of applicants’ financial situations and personal circumstances, and also limit the numbers who fall behind on credit commitments.
An unthreatening SMS check-in can start a fruitful dialogue with people who miss payments, and prompt a short digital interview to establish the reasons why, as well as the borrower’s intention or capacity to pay outstanding credit.
Our experience suggests 80–90% of people complete this when prompted, a higher rate than traditional phone-calls or Open Banking. Information provided by consumers can be validated for accuracy, allowing decisions which are just as accurate as those based on historic credit records.
Used in collections, this sensitive approach supports compliance with the FCA’s Treating Customers Fairly obligations and reduces the strain on customer-contact teams. It is proven to deliver a 25% improvement in resolution time for outstanding credit, with no increase in debt referrals.
None of us could have predicted this pandemic, or the impact it would have on our economy at the start of the year. Therefore, let’s not punish consumers because we no longer understand the context they find themselves in. Instead we should approach them with compassion, care and an understanding of their real-time financial situation.
This article was first published in May’s edition of Credit Management, the magazine of the Chartered Institute of Credit Management (CICM).
