Rising inflation, record profits, rising delinquency rates, a recession that may be on the way; what to do???
Recently there has been plenty of talk about inflation, about costs rising across the board, including the cost of food and fuel. In NZ, the OCR (the official cash rate) has been lifted 10 consecutive times and is now at its highest levels since December 2008. This and talk of a recession means that not only is the pressure on financially; it doesn’t look like these pressures will ease any time soon.
It’s on for the government, it’s on for individuals and households, and it is on for companies, including financial service credit providers.
KMPG recently published their Financial Institutions Survey Reports for both the banking and non-banking sectors.
Across both sectors, profits have increased year on year, although the 17% increase in profit to a record-breaking $7.18 billion for New Zealand’s banks has certainly drawn more attention.
On the other hand, Centrix’s recently published February Credit Indicator, shows climbing arrears across all portfolios. It’s important to realise that this deterioration in portfolio quality is already baked in. These rising arrears typically mean an increase to not only losses in the form of gross charge-offs. Those rising arrears also often mean rising collections activities costs as more account roll into arrears, lower recoveries and an increase in the provision for doubtful debt.
So, all in all, not great.
So, on the one hand, we have everyday Kiwi’s struggling with their repayment obligations due to inflationary pressures, and on the other hand, we have banks and financial services organisations continuing to grow their profits year on year, despite these challenges and rising arrears.
Hmmmm, what to do?
Here’s a radical thought – how about banks and financial services institutions stop applying collections fees to accounts that are in arrears?
Before said banks and financial institutions take me out back and have me shot, hear me out.
A quick refresher on risk-based pricing:
Risk-based pricing is frequently used by banks and financial services providers. It isn’t groundbreaking, and it isn’t new.
In essence, risk-based pricing means that different interest rates or pricing terms are applied to different customers, based on their creditworthiness. In layman’s terms – higher interest rates are offered to higher-risk customers, and lower interest rates are offered to lower-risk customers. The best-risk customers are offered the best (lowest) interest rates, and the highest-risk customers are typically excluded and denied credit.
It is in the organisation’s own best interest to be able to accurately estimate the creditworthiness of its customers.
Double-Dipping
The entire purpose of risk-based pricing is to take into consideration the costs that are incurred by higher-risk groups of customers.
These costs include increased arrears costs, which include collections activities, increases to the provision for doubtful debts, increased gross charge-offs and decreased recoveries.
Higher risk means that all these costs will be higher, and so, by applying risk-based pricing to their initial terms and conditions, these organisations acknowledge that they know these costs will be higher.
By applying Collections fees, in addition to risk-based pricing, one could argue that these organisations are double-dipping.
Punishing Customers trying to meet their payment obligations
Let’s say, for argument’s sake, that a $15 Collections Fee is applied to all accounts that are in arrears each month. The only time that fee is collected is when a Customer pays.
Banks and financial service providers want customers to pay.
And yet…
…those customers who do pay are punished; because in addition to paying their outstanding balance, they are also paying the Collections Fee(s).
Of course, those customers who do not pay are also charged the Collections Fee, but as they’re not actually making payments, they’re, in effect, avoiding punishment.
So, we have this somewhat bizarre situation, where customers who do the right thing and make their payments are punished, and those who do not, are not.
What behaviour are we actually incentivising?
Collections fees are legal. Yes, there are a bunch of caveats, including the fact that you can only collect incurred costs and that an organisation’s fee cannot be excessive relative to their competitors. (Yes, I’m paraphrasing).
So, this means that organisations only have to be as efficient as each other, as those costs incurred can be passed on to their (paying) customers.
Yes, I realise that this is an oversimplification; there are other benefits to running an efficient and effective collections shop; however, I wonder how much more efficient collections activities would become if the costs incurred could not be passed on to customers who are already struggling to meet their payment obligations?
The current setup means that higher-risk customers experience increased costs throughout the process.
Initially, they are offered less favourable T&Cs. Then as their higher propensity to struggle to meet payment obligations is realised, they are impacted by Collections fees (which I would argue have already been factored into their credit facility due to the initial risk-based pricing).
If the FIPS Banking Survey respondents really are that “concerned about borrowers’ ability to service their debt as interest rates rise”, perhaps scrapping their arrears fees could be one (small) way to help?
How to go about increasing efficiencies in a collections shop
I realise that increasing effectiveness and efficiencies in a collections environment can be tricky, especially with the added pressures of increasing inflation. However, that doesn’t mean it cannot be done.
One of the most powerful use case studies for machine learning is its ability to uncover patterns in data that are hidden from us. By uncovering these patterns and turning them into insights that can help drive change, we can improve outcomes, including:
arrears rates
broken PTP rates
best time to call
payments honoured
This, in turn, improves operational metrics and has a positive impact on delinquency rates, provisions for doubtful debts as well as charge-offs.
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