How to Manage Delinquent Credit Across the Entire Loan Cycle

Debt collections are in trouble - especially when it comes to delinquent credit. According to figures from the International Monetary Fund’s Global Financial Stability Report, non-performing loans make up 3.925% of total gross global loans.

While this figure is down from its high of 4.064% in 2014, certain countries exhibit a far more worrying ratio: countries such as San Marino at 43.4%, Greece at 36.3%, and Sierra Leone at 30.7%.

According to the Supervisory Banking Statistics Fourth Quarter 2016, the average rate of non-performing loans of large European banks stood at 6.17% - a figure that is growing, and that dwarfs countries such as Japan and the US which saw rates of just 1.5% during the same time period. The cost of servicing a delinquent loan, says Gartner, now stands at 15 times the cost of servicing a performing loan.

Unfortunately, it is often the symptoms that are treated rather than the cause: instead of working to avoid the problem continuing, businesses simply pour money into debt collection agencies rather than tackling the issue at its source. Instead, banks should take steps to reduce the issue of delinquency across every stage of the collections operation, from loan origination through to recovery.

Stage 1: Loan Origination

According to a report from Technavio, the global consumer credit market shows no signs of abating. They forecast that the market will grow at a 4.88% CAGR from 2016 to 2020 - but are lenders ensuring that the lines of credit they offer meet consumer needs in terms of suitability and affordability?

Financial institutions are duty-bound to make the best loans possible, using the highest quality information available. Doing so may require certain existing processes to be changed and improved, but will ultimately mean that the likelihood of future delinquency is lower.

Rather than relying on antiquated legacy systems, specialized origination systems can offer accurate and detailed risk analysis, document management, and productivity management, centralizing every element of information relating to the origination process. They can work with existing systems and test limits, as well as tracking performance-based metrics that can help to shape future loan origination processes down the line.

Stage 2: Credit Risk Monitoring

While credit risk is always assessed before loan origination, careful monitoring during the repayment period can enable businesses to better identify early warning signs and threats of delinquency.

A 2016 McKinsey report talks of the ever-increasing digitization of banking processes and how this digitization is transforming risk management. They report that the largest share of banks’ costs tends to be concentrated in risk-related processes, with the automation of credit processes and digitizing key stages in the credit value chain resulting in cost savings of up to 50%.

“At the stage of credit monitoring and early warning”, the report says, “advanced analytics and fully leveraged internal and external data could improve risk models for identifying issues across different segments.” And we agree. By implementing solid scoring tools, banks can identify trends in early warning signs that will help to shape future decision-making and improve the efficacy of customer account management.

A 2017 market study from fintech firm FIS reveals that around 2 in 5 corporations say that they either infrequently or never score existing portfolios for assessing credit and collections risk. On the flip side of that, the same report talks of how best-in-class firms are using statistical-based risk models that look at internal experiences with individual customers to calculate a monthly risk score, thereby determining the collections strategy for those customers.

Such scoring tools can be found in specialized collections software, looking at every single phase of the credit risk cycle to enable businesses to use the past behaviour of delinquent customers to flag similar behaviours in those earlier on in the cycle. With such flags in place, systems can be put in place to better manage these accounts before delinquency is reached. Tools include:

• Testing limits and tracking performance-based metrics  for a better understanding of the loan cycle, and where delinquency begins.
• Using visualizations to display tables, diagrams and support images that can be used by your team to understand a variety of account scenarios, allowing decisions to be made based on the previous behaviour.
• Compiling data from all risk cycle phases to gain an accurate, long-term, and complete picture of potential delinquencies to present to decision-makers.

Stage 3: Collections and Recovery

A robust collection and recovery process requires three things: due diligence, documentation, and streamlined strategies.

Effective management of delinquent credit requires gaps in operational efficiency to be identified and improved rapidly.

If using external collectors, consider analyzing their performance to date. Are there any particular strengths or weaknesses that you can identify, that may enable you to improve processes? Mapping their strengths and weaknesses can help you to create data-driven strategies that improve the ratio of promised to collect payments.

Wholesale changes to existing processes and systems take time - however, leaping straight in with the big changes isn’t necessary. Start small, and identify your key goals for improvement.

Education and professional development of your team are required on an ongoing basis, ensuring that it’s not just processed, but also the knowledge that is up to date. Measurement and monitoring can pick up areas for improvement as soon as they are needed, making the entire process far smoother.

Where possible, keep processes in-house - and in one central location. A recent Gartner Retail Banking report highlights the extent of the current inefficiencies in the collections process, with different stages of collections managed by different departments - often in different locations - with a huge disconnect between the three. Keeping everything together will make the collections and recovery process smoother, rather than more complicated and fragmented: use external agency support only when vital, and when your business can carefully and closely monitor partnership activity.

Combined, these elements will create a collections system that is as efficient as possible.

Simply spending vast sums on external debt collection agencies may seem like the easiest way to manage delinquent credit - but it is a sticking plaster for the real problems. Instead of treating the symptoms, financial institutions should consider resolving the cause of the problem, focusing on the entire loan cycle from start to finish. This way, the likelihood of delinquency can be predicted more easily and accurately and dealt with before it escalates too far.