Credit Risk Management in a post-COVID-19 world

With the onset of COVID-19 the risk appetite of lenders has, out of necessity, required a re-think. This has meant each organisation’s underlying activities, processes and procedures have had to shift in response. A few examples of changes lenders are considering include:

• The previous prohibitions around lending to the unemployed or underemployed may need to change.
• The methods used to verify income for certain customer segments may no longer be relevant and need to be revisited.

The way credit is managed across the customer lifecycle (from origination through to loss recovery) needs to be reconsidered.

• The current approach to score cut-off management (i.e. approvals, declines, and credit referrals), loan amount / credit limit determinations, and other terms of business set at the point of origination, need to be reviewed to ensure they are in line with any adjustments to risk appetite.
• Effort should be prioritised to certain aspects of the lifecycle. In particular, there is a current shift in focus to the collections function - typically loans that are 15 days or more late on payments - including debt sale. 
• The conventional approach of selling debt to ‘debt purchasers’ will be disrupted due to COVID-19, and potentially lead to price fluctuations.
•  The immediate focus is on collections at the moment, and rightly so as lenders are working with their most vulnerable customers to provide access to hardship arrangements.
• From an account management point of view, there are a myriad of strategies that can be deployed, depending on the lenders’ appetite and the product type. For example, credit card portfolios have a lot more levers, due to the fact that there are more product features that can be switched ‘on’ or’ off’, or managed on a continuum. Examples of these features include credit limits, cash advance limits and spending blocks.
• Through the Global Financial Crisis (GFC), some lenders implemented strategies and processes to perform thorough due diligence on long-term ‘purchase inactive card’ customers who wanted to use the product again. The thinking was that a customer suddenly seeking a previously inactive credit product may be a signal of stress. 

Lenders need to understand what data is leveraged to make credit decisions. Typically, this is data supplied by customers, as well as the data the lender may have on that customer, bureau data, and other external data sources such as bank statements and payslips.

• Lenders also need to understand how this data will be impacted by COVID-19, and what these changes will mean for managing customers’ credit going forward.
•  Bureau scores may be affected by the fact that, under the comprehensive reporting regime, the Repayment History Indicator will look different for customers placed on payment deferral terms.
• Lenders will also need to consider the impacts to operational (assessment) and financial (measurement) credit risk models, as the meaning of the inputs into these models is changing. 
• Forward-looking overlays will need to be considered, and lenders will need to take into account any guidance from APRA on the treatment of loans during this period

With the rapidly changing credit landscape, it is critical to set up the right monitoring infrastructure to support lending decisions. This will be a key enabler to managing credit risk over both the short and long-term. It won’t be feasible to monitor every segment of the credit book, and lenders should define and prioritise key segments that make sense for them. Some of which may include:

• Unemployed customers
• Underemployed customers
• Customers that have had their income reduced (which could potentially be identified through their transaction accounts)
• Customers employed in sectors that have been designated as ‘high risk
• Credit Card Customers who have been long-term purchase inactive.

• Portfolio dynamics and trends will become very short term in nature, and changes will happen far more frequently than in pre-COVID-19 times. This will need more frequent monitoring, as well as ongoing forecasting and reforecasting of key metrics.
• It is critical that lenders document the actions they take and create a portfolio chronology for future reference when customers, Boards, and regulators ask ‘What happened?’, ‘What did you do?’, ‘Why did you do it?’, and ‘What was the impact to the customer and the organisation?’

People capability will be the main enabler for organisations to successfully navigate the challenges ahead.

• Lenders should see this as a people development opportunity, ensuring their people have the right access to decision-makers and, where appropriate, are granted decision-making responsibilities to expedite response to customer needs. 
• In tandem, organisations need to ensure that the capabilities of their teams are enhanced through exposure to adjacent business areas.
• Key staff working in originations will benefit from being involved in and understanding aspects of account management and/or collections.
•  There is also an opportunity to give people stretch opportunities and improve the capability of the organisation as a whole. 

Lenders that respond to their immediate priorities in a prudent and effective way will minimise their downside risks, while building out capabilities that will make them better at managing the very important credit risk challenges ahead.