Several years on from the world financial crisis, banks are still having to deal with its consequences. Besides the financial impact and the damage to their reputations, banks have had to learn to operate in a new world – a world of flat economies and rising levels of customer debt. Non-performing loans have increased and customer indebtedness, in general, has been seen to have a significant effect on the banks’ net profitability. Increasing collection costs, growing bad debt write-offs, and the requirements for higher provisions against loan losses have all combined to make managing credit loss a key business driver, with a direct impact on profits.
The increase in non-performing loans is not a phenomenon only seen in Western banks. In the medium term, it is clear that NPLs are also set to rise, for a different set of reasons, in expanding and emerging economies. According to a recent study by the Institute of International Finance (IIF), NPL rates in emerging markets such as Asia’s and emerging Europe’s continue to deteriorate with the outlook still being negative.
In emerging Asia, banks witnessed deterioration in NPLs in 2013 Q3, following a series of deteriorating quarters. Furthermore, most banks participating in the survey indicated that they expect a further rise in the percentage of NPLs in their lending portfolios over the next three months. As for emerging Europe, 2013 Q3 has brought another rise in NPL ratios. A recent Ernst & Young forecast estimated that NPLs would continue to increase around the world, rising by 16% in 2013, from 5.6% of all loans to 6.5 percent.
The rise in NPLs has made credit risk management an urgent issue – not just for the banks, but for regulators and auditors, too. Access to capital, from wary shareholders or depressed financial markets, has been limited, and banks are having to develop a more balanced approach, moving away from business models that relied on high levels of liquidity funding and ready access to low cost capital. Within the new business models, there is a need for more proactive and effective collection and recovery strategies, making full use of today’s flexible, responsive operational and IT systems to provide the agility to respond to new and emerging risks in the loans market and the functionality to deal with legacy risks inherited from earlier years.
Financial institutions face the challenge of managing a growing numbers of delinquent customers, while holding or cutting operational costs. This will mean using collection scoring techniques to assist in the early identification of problematic cases and to impose a strong barrier to customers reaching recoveries, where direct and indirect management costs are much higher. Segmentation of collection activity is a key success factor for efficiency and productivity, especially in retail banking. The segmentation strategies that are chosen must maximize the number of self-cure accounts (to avoid unnecessary cost and customer irritation), identify the accounts that need to be worked more intensively (to avoid escalations to higher delinquency levels), and generally enable more to be collected without additional effort.
The banks that have risen to the challenge have either restructured their internal Collection & Recovery (C&R) organizations or rethought their collection strategies – usually both. The “best practices” that have emerged from this period of intense pressure can be summarized under the following headings:
- Create a single collection management authority and one centralized collection organization
- Divide management into phases, progressing according to clear rules
- Use customer/account analytics to segment the delinquent portfolio
- Adopt a hybrid account/customer-level approach
- On workload distribution, combine the pool approach with assigned ownership
- Put in place centrally defined collection tools
- Select external agencies carefully and monitor them closely
- Employ and train dedicated collection staff
- Improve capacity planning
- Provide effective and targeted communication scripts
- Measure performance and provide incentives for your collectors
- Develop multiple contact channels
- Exploit the potential of technology
Such “best practices” employed by the most effective Collection & Recovery departments of financial institutions around the world, require support from specialized C&R software solutions. But, broadly speaking, the systems in use today have failed to satisfy the business need to efficiently manage credit risk. The solutions seen in many banks have often been deployed piecemeal over time to address requirements for specific products and specific phases of the collection process. Though they may have offered significant improvements over earlier manual methods, these systems have now reached the limits of their effectiveness. Some banks still rely on semi-manual processes with import and export of data into spreadsheets for analysis. But most use multi-component systems built up over time and often acquired as adjuncts to core banking solutions or for the application of scoring data. These systems rely on program code to manage workflows and collection processes and involve risky movements of data between modules to provide full process coverage. Where change is infrequent, this approach, while costly, may still be able to handle standard collection workflows effectively. But these applications start to become a liability to the bank when the pace of change increases.
What is required by financial institutions that wish to excel in the area of credit risk management and collections, are software systems that:
- Incorporate business knowhow from an international environment
- Provide true end to end coverage for C&R operation, including :
- All credit financial instruments (i.e. amortized loans, revolving loans, leasing, SMEs, corporate, …)
- The whole lifecycle of accounts, from pre-Collection to Litigation & post write off management
- Incorporate a wide variety of tools in one integrated solution, for example Scoring Tool, Analytics, Strategy Manager, etc.
- Are highly parameterisable & maintainable by business users, without the need of intervention from software engineers
New generation C&R systems that comply with such specifications achieve a remarkable ROI and their implementation may also be used as a tool for rethinking collection strategies in accordance to the “best practices” mentioned earlier.
For further information on the global C&R “best practices” that support today’s most successful collection and recovery operations, on how the best specialized C&R software systems optimize performance, as well as on what to look for when shortlisting suppliers of C&R systems, please download the White Paper “Collections & Recovery Meeting the Needs of a Changing World” by EXUS (click here).
EXUS is an innovative software company founded in 1989 with the vision to transform the costly and complex enterprise software industry – make it simple, accessible and exciting. EXUS has focused on one core capability: credit risk management for financial institutions. EXUS’ Financial Suite (EFS) covers the whole Credit Risk Management Cycle, from Loan Origination to Debt Collections and Recoveries. Its flagship product, EFS Collection & Recovery is the choice of both regional banks and large banking groups, as it combines full coverage of all phases of the arrears management, from pre-Collection to post Write-off management, with the flexibility required by end-users in order to configure the system through the usage of intuitive visual tools and without the need of intervention by software engineers.