Calling all originations and credit risk managers.

Is this the right time to focus on originations management?

Have you ever felt truly cursed?

I don’t mean the ‘having a bad day’ type of cursed, but rather the ‘how can things get any worse’ type of cursed.

Until the dawn of this new decade I had always considered myself to be lucky. I had worked my entire career in an industry that I loved, starting off in lending at banks, then moving to credit risk consulting and finally credit risk software, specifically for decisioning.

My career started as a credit risk analyst in the 1980s and each decade since then has presented its own specific challenges, with cyclical economic crises and recessions, wars and natural disasters.

However, nothing in the past has been able to prepare us for what has happened since 2020.

• Covid-19 pandemic
• Mass layoffs
• War
• Food shortages
• Inflation
• Currency crashes
• Cost of living crises

Whilst many may not agree that this extensive list all adds up to being cursed, the majority of people would definitely agree that all of these combined have resulted in unprecedented challenges for credit risk managers.

Turbulent Times

The fact that we are all now indeed in turbulent times cannot be disputed, here’s an article from the Daily Mail, dated 01 September 2022:

“Buy now, pay later giant Klarna sees losses quadruple. 

Buy now, pay later (BNPL) firm Klarna saw losses more than quadruple in the first six months of this year amid mounting doubts over its business model.

The Swedish company, which at one time was Europe’s most valuable private tech firm, reported a mammoth loss of GBP 502 million for the first half of 2022, compared to a GBP 114 loss in the same period last year.

This came despite the amount of goods it helped to sell by offering its credit service rising 21% to GBP 35 billion, while revenue climbed 24% to GBP 816 million.

 Klarna, which is the world’s biggest provider of BNPL credit – serving 150 million customers including 15 million in the UK – attributed the dismal results to higher credit losses in new markets and a rise in employee costs.

 …it has been hit by a slowdown in consumer spending amid soaring inflation.

The darkening economic outlook means Klarna has suffered a painful fall from grace over the past 12 months.

Month               Klarna Value

Aug 2019          GBP 4.7 billion

Sep 2020          GBP 9.2 billion

Jun 2021          GBP 39.2 billion

Jul 2022           GBP 5.8 billion

Moves to improve oversight of the sector come amid concerns that BNPL lures people into borrowing more money than they are able to feasibly repay, leaving them more exposed to cost-of-living shocks.”

What is very interesting about these figures, is that Klarna experienced its greatest growth and increase in valuation during the height of the pandemic when BNPL became all of the rage, particularly amongst young consumers.

The pandemic was indeed a boom time for Klarna and its many lookalike BNPL competitors and the saying “a rising tide floats all boats” springs to mind.

In an article on 01 September 2022, The Daily Mail identifies the fundamental flaw in the BNPL model, which explains why this type of lending may go from boom to bust in the upcoming recession:

“On a more human point, allowing more vulnerable customers, especially the young, to pay by instalment and with no credit checks encourages them to buy far more than they would otherwise.

If you look at most online retailers, as soon as you go to pay, the Klarna option pops up alongside traditional payment systems. It’s a tempting offer and takes a strong will to turn down such goodies.” 

The downgrading of the credit risk manager

This observation is entirely subjective and non-scientific, but once the Covid-19 restrictions kicked in and the business world flipped over to Zoom and Teams calls, it became very apparent that many of the new start-ups offering digital loans and BNPL products were operating with basic or no credit risk management expertise.

It seemed that overnight the role of a credit risk manager (from originations to write-off) had been eradicated or overlooked. Most of the calls we had during the pandemic were with Product Management, Data, Analytics, Marketing and Customer Experience (CX) personnel.

Calls including risk management were perhaps only 20% of the time and the remaining 80% of calls were with the new roles that appear to have taken over the reins of power, as they were definitely in charge of all of the decisions that were made.

Perhaps one explanation for this is that BNPL does not require credit checks and so it was not a product that was viewed by the lending organisation as coming under the purview of the credit risk management team.

Needless to say, this outlook held by many new lenders and Fintechs is now being discredited as the cost-of-living crisis bites and bad debt increases.

What must not happen now

As a veteran of many, many crises and economic busts, I have had the opportunity to see ‘the good, the bad and the ugly’ in terms of responses to the challenges.

The types of responses that must not happen now include:

• ‘Crisis, what crisis?’ – this is where the lender acts in denial and refuses to accept that there is a storm heading their way. Imitating an ostrich with its head in the sand is viewed as more preferable to making tough decisions.
• ‘Throwing the baby out with the bath water’ – whereas the previous mistake was not taking any corrective action, this error is taking too much corrective action. In this situation, a lender would have a knee jerk reaction and cut down on all lending, thus declining good as well as poor credit applications.
• ‘Tactics, not strategy’ – this is where a company wants to be seen to be doing something but focuses on reactive measures rather than proactive and portfolio level management. An example of this that has occurred in the past is to introduce specific lending criteria and limit decreases in cities and regions that have had factory closures, or natural disasters. (This often results in public relations disasters).
• ‘Playing the blame game’ – this is very common in organisations with a high degree of internal politics and where individuals and departments waste time blaming others for the mess, rather than focusing on fixing the leaking ship.

Summary

Part 1 of this two-part blog sets the scene for this highly challenging time we (as loan originators) all find ourselves in right now.

Part 2 provides some practical tips as to what a lender should do to manage originations during a turbulent period such as 2022.

About the Author

Stephen Leonard is the founder of ADEPT Decisions (www.adeptdecisions.com) and has held a wide range of roles in the risk industry since 1985.