Consumer credit in the times of COVID-19
“Our greatest glory is not in never failing, but in rising every time we fall.” - Confucius
As the COVID-19 responses kicks in across most countries, as we settle into our rhythm of working from home and work processes adjust to distributed operations, it is clear that the economic repercussions of the pandemic will last beyond the next weeks and months. A recession of sorts is looming in front of us, and all of us I am sure, are kicking off our task forces to think through the organisational responses to the downturn.
For those of us who have seen the earlier recession, there are perhaps questions on which of our learnings will be relevant to this one and what will be the new things that we will have to tackle this time. If we have learnt anything from the last recession, it is that things change rapidly and derail the best laid plans. While this period will result in some form of pain, organisations that last through this typically come out stronger at the end. It has also taught us that a steady hand at the helm is invaluable and approaching the situation with determination, positivity and a clear plan helps in making the best of the situation.
Here are some key themes to consider as we look to manage the economic impact of this pandemic. The intent is to use the best practices and learnings from the previous time and apply them into the current environment that has seen major changes in technology and consumer behavior over the last few years. Some of these insights should help provide a window to build for the future on the foundations of the past.
Grow digital acquisition
COVID-19 is perhaps going to force the largest shift in working habits of humanity with most organisations opting to work remotely. The direct benefits of this is the forced adoption of technology and digital processes. Humankind has been nothing if not inventive in the face of necessity. Consumer banking on the other hand has been struggling with digital adoption at low levels across most markets for several years now. APac today has an estimated digital acquisition rate in its early teens despite the growth in telephony, infrastructure and changes in consumer habits.
In recent history, the largest shift into digital payments took place in India during its demonetisation exercise. Necessity forced digital payment adoption in the country – and since then, these habits have stayed with Indian consumers. Taking a leaf from the Indian example, consumer banking in the rest of the region could, similarly, make a major shift into digital acquisitions now. While the industry has faced its share of challenges in making incremental shifts into the space, the current situation could be the catalyst for banks to step up processes for greater digital acquisitions.
In a recent study of infrastructure across multiple countries in APac, the conclusion was that while the systems had matured enough for a full transition to digital in the last few years, patchwork systems built on legacy applications were not allowing a clean shift.
Rebuilding legacy applications for the cloud and moving to fully source customers digitally, could hence be the first theme of focus as we head into recession, against the anticipated reduction in acquisition cost. This digitisation could support, not only new customer acquisition, but also play a very significant role in digitally growing relationships with existing customers by making the process of acquiring a new product easier.
Recalibrate acquisition scorecards
One big learning from the 2008 financial crisis was the necessity to re-calibrate underwriting processes around ‘black swan’ events. This is an activity to be picked up in consumer banking post haste at this point. Today’s machine learning (ML) methodologies provide financial institutions with the ability to quickly calibrate scorecards with incoming data, a capability that did not exist during the earlier down cycle. Moreover, these ML methodologies use data flows to effectively learn and adjust to change in consumer through the door (TTD) population. Again, it has been seen in the past that these TTD population shifts happen a lot more during a recession as the sales processes and consumers adjust to changes in credit requirements. This is a great time for organisations to strengthen their ML practices in consumer credit by investing in this capability for the future . At the same time, organisations should not overlook the use of alternate data in evaluating consumer credit. These additional data points are likely to offer significant information on the more vulnerable economic groups, allowing for better decisions and swap-sets in this segment.
Recalculate Economic capital
This may sound like a truism but recalculating economic capital to account for changes in consumer behavior and consequent losses in this phase is a necessary step. Dimensioning the extent of capital required to cover potential credit losses in the period is the first step in preparing for a downturn.
Often the evaluation process is not straight-forward and requires scenario planning. Capital access in this phase is wrought with difficulty. Therefore, knowing in advance your capital coverage and requirements may give an insight into the energies to be expended in and urgency around capital raises. Looking at this as a developing situation to evaluate impact will ensure that it is a dimension that is not missed, negating the need for it to escalate into crisis in future. The technology progress in the space allows for a more frequent recalculation as well as detailed scenario planning and using it to its fullest will ensure that there are fewer surprises in the long run.
Active limit management for revolving lines
Downturns are the right time for increased effort in active customer limit management. Ensuring that consumer and business limits are handling at a holistic level rather than at a facility level is essential. Rightfully, most consumer banks have moved to tracking limits at a customer level, rather than at a facility level, by now.
Facilities like bank overdrafts and credit card limits tend to see peak usage in the period as consumers adapt to tougher market conditions. Making sure that the limits for these revolving facilities are actively managed makes a huge amount of sense at this point. This is also the right time to look at pricing and risk in unison and as such a strong recommendation would be to move to using optimising tools in these areas.
Customer centric collection strategies
Some consumer segments are likely to be more impacted than others during a downturn. Consumers in jobs or businesses that are going to take a bigger impact from the new business operating model will likely feel the pressure a lot more. Similarly, consumers at the bottom of the pyramid who have lower levels of their income covering non-discretionary spends will experience an even greater impact.
Conducting a full analysis of the portfolio to identify the vulnerable consumer and business segments will be a start. The next step for each organisation is to develop strategies to deal with this segment. This could range from allowing them extended repayment periods, installment holidays to evaluating portfolio sale.Conducting a full analysis of the portfolio to identify the vulnerable consumer and business segments will be a start. The next step for each organisation is to develop strategies to deal with this segment. This could range from allowing them extended repayment periods, installment holidays to evaluating portfolio sale.
Ensuring a clear and optimal strategy in the management this segment is a necessity. This is especially relevant to developing economies, where these vulnerable groups are often the consumers of the future. Hence, it is important to avoid making short-term decisions. A strong collection system with the ability to actively manage consumer collection strategies is a key requirement. Though ignored during growth phases, collection processes will need much larger investments in the current climate.
Working with regulatory shifts to support demand and supply kickstarts
Government action during the last recession impacted banking the most. Interest rate changes, money supply fluctuations, as well as support packages to specific consumer segments tend to create big shifts in the industry – as seen in the aftermath of the 2008 financial crisis. Financial institutions which are attuned to these big shifts will be able to make the best of government intervention(s), resulting in positive impact to their consumer bases.
We are seeing some key shifts in the way governments are reacting to the current crisis with some of them even looking at the option of directly crediting funds to vulnerable segments to protect them and maintain consumer demand. Accounting for these actions in strategy on the ground will help the banks gain a strong tailwind. Equally, given the supply side disruptions that COVID-19 has created, it is likely that most governments will also take strong action to support their SMEs. This sector may hence see a lot more action in the coming period consequently and the banks will do well to invest in their capabilities to support this customer segment. The SME banking capabilities in general have been a little more manual compared to the consumer lending space and this could be the time to invest to grow the capabilities here.
Focusing on consumer requirement changes
It is also a reality that there will be big shifts in consumer behavior and credit habits during this phase. Banks will do well to understand these shifts and play them to their advantage. There has been a tendency with banks to look more closely at managing the risks in this phase rather than the upsides they could get with wealth strategy shifts in their top consumer segments. This phase will see strong changes in asset allocation which the banks will do well to tap into.
Operational efficiency within the organisation
Lastly, it is important for the banks to evaluate their processes with a view to bringing in operational efficiencies and automation. Areas like analytics are undergoing a big shift at this point and are a key competency, which the banks should develop in supporting this phase. Banks will benefit from reevaluating their core strategies in the people intensive side of their business to invest heavily in robotic process automation (RPA) and in the IP intensive side of their business with the right people strategies and capabilities.
As we prepare ourselves for the time to come, we will do well to remember the key learnings from the past. Periods of recession have the tendency to make or break organisations. This is largely driven by an organisation’s ability to formulate an action plan to face the change and then weathering the storm with agility. Banks and financial institutions can choose to take on these challenging times to build their organisational strength for the next phase of growth to come.
Read full article
Artificial intelligence has tremendous potential to be the catalyst to push consumer finance to the forefront of serious transformation and growth.Learn more
At Experian, we value a workplace culture based on inclusion, innovation and the diversity of perspectives.Learn more