Global Market Update No. 6. Current & Future Trends: The Comprehensive Reporting Issue

Transcription

1 Global Market Update No. 6 Current & Future Trends: The Comprehensive Reporting Issue

2 Welcome to the 6th edition of the Experian Decision Analytics Global Market Update series. After a long and winding journey, over many years, Comprehensive Credit Reporting (CCR) is finally almost here. There is still much to be done but it is now clear that come April 2014, the new credit reporting framework will be in place. For some, this might still seem a long way off but there is a great deal to be done. Organisations need to start by considering how they are going to approach this change, be it as an early adopter or a market follower. Historically credit data has predominately been used within originations as a knockout for high risk accounts. The legislative changes enable more granular use of data but across the entire lifecycle, including collections. Combining the new information with internal data sources and/or other customer profiling (such as Mosaic), enables lenders to target actions at specific customer groups. Lenders will also need to be smarter in the way that they use Credit Reference Bureaux (CRBs). Optimal multi-bureau capabilities and strategies will ensure improved, and cost effective, decision-making. Lenders also need to be considering how, and which, new models will be developed and utilised to improve risk assessment, customer affordability and/or loss likelihood. With so much to do, organisations will need to have their implementation plans in place with clear prioritisation of initiatives. Experian has worked with many organisations across the world to do just this. As such, we are able to help lenders understand the opportunities and also the potential pitfalls in the adoption of this new legislation. Regards Nigel Butler Director, Experian Decision Analytics Let s talk about it. Comprehensive Credit Reporting Use of Credit Bureau Based Analytics throughout the Customer Life Cycle In 2006, the Australian Government requested the Australian Law Reform Commission, ( ALRC ) to conduct a review of the Privacy Act 1988 to determine if the Act gave sufficient privacy protection to the Australian public. After two years, the ALRC released its report to the Government and as a result of the recommendations made by the ALRC, legislation has passed to enable significant reform. A key element of the reform is the ability for more comprehensive data to be provided to a credit reporting agency. Research shows that comprehensive credit reporting (or positive data) provides richer information on a consumer s payment performance and levels of commitment. This can assist lenders to make more accurate credit risk assessments throughout the customer life cycle. Experian and global independent research both confirm that use of positive credit bureau data increases the predictive power of traditional or negative only credit bureau models. The introduction of positive data allows new and enhanced bureau-based value added analytic products and services to be created, which can be used independently or in combination with improved traditional credit bureau scores. Collections Management Recoveries Account Prospecting Data Analytics Retention Reactivation New Business Cross sell Up sell Figure 1: Where positive data can be used throughout the customer life cycle under Australian legislation Let s explore Experian s global experience of the benefits of positive data across two customer life cycle touch points, Originations and Collections (refer to Figure 1 for the full lifecycle touch points): Originations Used in combination with internally developed application scores, more predictive bureau scores leads to better informed accept or reject decisions. More accurate risk prediction also creates a swap set, in particular for marginal applications around the cut-off score, i.e. previously accepted higher risk applications can now be declined, and vice versa. This leads to improved portfolio quality. When used to drive origination strategies, bureau scores can improve initial credit limit assignment and make risk based pricing more effective by rewarding good customers rather than only penalising bad ones. Operationally, availability of limits in the positive reporting environment improves internal serviceability models, can reduce the need for verification (e.g. customer stated limits can be verified against those held on the bureau), and help with meeting responsible lending obligations under the National Consumer Credit Protection Act ( NCCP ). At a macro level, bureau based benchmarking services allow organisations to compare their individual portfolio level performance against the market and their peers. This allows an organisation to determine the best course of action into future strategic acquisition strategies. Globally, Experian provides a suite of bureau based analytical metrics to allow organisations to effectively benchmark themselves. Account Management and Collections Use of bureau data outside originations is not currently widespread due to its cost and the limited use on a small, high risk population. In the positive data environment, repayment history over the last 24 months will be available and this richer information will lead to the development of bureau based models and scores that will provide good support account management and collections strategies. For example, globally, Experian has developed bureau based collections scores that predict likelihood of payment in the next 3 months for currently delinquent accounts. Recovery models have also been developed that predict likelihood that non-paying accounts in default will respond to further debt recovery action. When used in collections strategies, collections scores can result in significant cost savings by treating accounts with a high likelihood of repayments with fewer or more cost effective actions or none at all. Similarly, recovery models can lead to higher recovered balances, through the application of analytics to prioritise resources to accounts with higher likelihood of paying back. About Jean Abraham Jean has worked in credit risk management for 15 years, primarily with Experian Decision Analytics but also with ANZ on their Basel II program. He has an Analytics background, with extensive project experience in delivering analytical solutions including Basel II loss metrics for Retail portfolios. This is complemented by experience in design and delivery of decision solutions, principally for originations. More recently Jean has developed a particular interest in Comprehensive Credit Reporting, its impact on lenders and the industry and helping lenders prepare for the new legislation.

3 Changing laws and what they mean. As a result of the passing of the Privacy Amendment Act, the collection, use and storage of personal information by Government Agencies and private sector organisations will change. Consequently these entities will now need to carefully consider their existing arrangements and those currently under negotiation to ensure compliance by March For those people involved in implementing and working through the new regime; the work has just begun. The new legislation provides a lot of new opportunities including streamlining and improving the credit application and decision process, reducing bad debt through better customer management and facilitating risk based pricing. The first question that the amendments raise is perhaps one of over and mis- regulation in the name of consumer protection. There is an underlying clash between the objective of the National Consumer Credit Protection Act 2009 and the changes to the Privacy Act. Under the former, lenders are obliged to make enquiries regarding a borrower s financial position and to verify that position. This information allows lenders to assess if the product is appropriate for the borrower. However the amendments introduced by the Privacy Act still prohibit the use of the most powerful tool for that assessment, the account balance. Thus legislators have entrusted the lenders with the responsibility but denied them the most relevant tools to fulfil their job. Experian research has demonstrated that by including account balance in the assessment process nearly 14% more bad debt is highlighted within the population with derogatory data and more than 18% of bad debt is highlighted within the credit active segment, with an associated dollar value in the millions. If account balance was included this would provide a more accurate estimation of credit indebtedness and thus affordability. Further still the amendments made within the definition of default information and in particular the increase of an amount that is overdue from $100 to $150 will impact roughly 1% of the default accounts that sit in that range. For how many people is not making a credit card or phone bill payment an early indicator of subsequent default on a larger mortgage or personal loan product? This simple change in the definition will have an adverse impact on the collections process, with the largest proportion of these occurring within the telecommunications industry and credit card portfolios. The industry knew they were never going to achieve all that they wanted through this reform. However, once comprehensive reporting kicks in, the ball will be in their court. Regardless of whether it is a Tier 1 bank or a smaller lender, every part of the application process will be affected. Every organisation and agency within the industry will need their capabilities evaluated and the gaps highlighted. This process will range from simply up-dating application forms and training staff, to up-dating infrastructure (i.e. establishing connection to the bureaux), modifying current application processing systems and decision agents, training underwriters and modelers and lastly informing existing customers. The prioritisation of each of these steps will depend on the organisation s size, structure and business objectives, however it must be assumed in the next 15 months building and updating the infrastructure as well as addressing the legal requirements will be at the top of the list for all. We should be mindful that while the cost of development or updating of software is somewhat well understood within the industry, the cost of enforcing and implementing all the legal requirements is not. An understanding of the impact of these costs will be needed to manage profitability and customer impact. So far larger lenders have been investing more time and resources into the appropriate infrastructure compared to the smaller lenders. However the sheer size and complexity of these institutions makes it more difficult to grasp the whole picture and manage the transition process. On the other hand smaller lenders have not made as much progress and many are only just waking up to the impending changes. The need for connectivity and change into their origination systems will soon be top of their agenda. There is still a lot of change that will need to flow through, the Australian privacy and industry codes are still being developed and once completed will have a great impact on the way all new amendments by the Act are to be implemented. Multi-bureau: What are the benefits? Today the predominant use of bureau data is at the point of application and generally only one bureau is called. However, with the arrival of Experian to the market there is now the opportunity to use all three bureaux. One of the main reasons for a provider to use a multi-bureau strategy is to access the broad set of data available for making decisions. For the best decisions it is prudent to have an extensive understanding of an individual and this can be achieved by accessing the most appropriate bureau for each case (or multiple bureaux where practical and cost effective). The development of customer profiles based on multi-bureau decisioning strategies can optimise value-for-money product offerings across all data providers. The benefits of multi-bureau include: Data Coverage: It is common for data suppliers to not supply to all bureaux in the market and as such different bureaux will have different data. Examples of this may include industry preference for a particular bureau or pricing based preferences. As such, it may be prudent to use the multi-bureau strategy for niche populations, or invoking a secondary bureau call where, for example a consumer has a thin file to determine if there is more data available Niche Populations: As mentioned above a credit provider may implement a strategy that orders a specific bureau choice for niche populations (e.g. youth segments may go to Bureau A, mature segments may go to Bureau B etc) Additional Data Sources: Where a bureau has unique data sources preference may be given to that bureau where their data is useful in the decision process for particular product or customer segments Service Availability: The level of resilience, up-time and disaster recovery is important and where a provider has concerns about a bureau, the availability of multiple bureaux allows timely decisioning in the event of an individual bureau experiencing problems Regulatory Protection: Some providers see multiple bureau strategies as a way of protecting themselves in the increasingly complex regulatory environment by demonstrating that their systems use multiple credit bureaux making the best decisions for their business and their customers Value-Add Services: Each bureau will have its own set of products (e.g. scores, triggers, segments) which will add value to the provider. The additional value-add from these products may influence the choice of a primary bureau and/or the use of a secondary bureau Data Quality and Matching: Having clean data is of the utmost importance and optimum value will be gained from having the cleanest data. Each bureau has its own matching and cleansing routines so a choice of bureau may be made on the match-rate along with the cleanliness of the data. There are occasions when a second bureau may be used to find the harder addresses as these have simply not been matched at the first bureau Connectivity: Making it simple to connect and shake hands with a bureau from a data perspective may lead to switching to another bureau Price: There are occasions where the decision to use a bureau may be made with price in mind. Different bureaux may offer varying price models which may be attractive to different businesses in certain scenarios Customer Service: Easy connection to the bureau is a given, however the approach to customer service will often lead to a provider choosing which bureau will be the primary supplier It is a combination of all of the above points that will lead to decisions on primary and secondary bureau calls, along with creating optimal strategies to gain the most out of the bureau data available and making the best decisions possible. CCR Adoption The speed at which Comprehensive Credit Reporting (CCR) is adopted will vary depending on the appetite of individual lenders, and as a result, so will the benefits. To summarise and compare the advantages and disadvantages of different approaches, the following classifications have been used; 2 Experian Decision Analytics Global Market Update No. 6

4 Abstainer: An abstainer chooses not to adopt CCR beyond the base principles of the legislation. Follower: Adopting a follower approach will mitigate some of the risks of being an early adopter but removes the opportunity to realise some early benefits. Early Adopter: An early adopter would be looking to use their appetite and ability to leverage positive data to maximise value immediately and therefore gain competitive advantage over those who don t. Abstainer Lender chooses not to provide or receive positive data Pros: + No additional development costs + No risk, no mistake Cons: Likely to be considered irresponsible lender* Customer confusion if other lenders/government/consumer groups communicate changes publicly Adverse selection, means application profiles will deteriorate, inheriting high risk accounts rejected by early adopters Missed opportunities from good, risk marginal declines Customer service likely to fall behind adopters Process efficiency gains not realised Going against the new political direction Follower Lender is fully ready for the major opportunities at or shortly after day 1 but plays safe by not introducing anything which might be considered controversial until it has been embedded in the market for some time Pros: + Potentially learn from others mistakes in the market + Allow others to take the heat should there be any adverse reactions from customers + Potentially slows down the general introduction of CCR (assuming market follows) Cons: Adverse selection means application profile could deteriorate inheriting high risk accounts rejected by early adopters May inadvertently fall behind due to speed of implementation Potential for some bad publicity in branding as others leverage best practice Lost opportunities from marginal declines Lost opportunities from improved customer service Process efficiency gains not realised immediately Increased risk of being considered irresponsible lenders* Early Adopter Lender views the introduction of positive credit bureau data as a major opportunity and focuses all reasonable efforts to ensure processes, tools, systems, analytics etc. are fully ready to exploit positive data as soon as it becomes possible Pros: + Take full advantage of benefits in accept rate or bad rate reduction and gain a competitive edge in customer service (verification, authorisations etc.) + Take full advantage of improved internal processes (process efficiency, fraud prevention etc.) + Potential to leverage as leading brand customer service, retention, technology, innovation + Shape the market, forcing others to follow (verification, fraud prevention, customer communication, hardship policies) Cons: Need to direct significant resources towards project in the short-term Risk of getting it wrong additional IT cost, bad publicity Credit licensees must comply with the NCCP (National Consumer Credit Protection Act 2009) including responsible lending conduct obligations. The key concept is that credit licensees must not enter into a credit contract with a consumer, suggest a credit contract to a consumer or assist a consumer to apply for a credit contract if the credit contract is unsuitable for the consumer. There is an obligation to make reasonable inquiries about a consumer s financial situation including fixed expenses such as repayment of existing debts. There is also an obligation to verify such information. CCR may well become the new standard by which compliance with NCCP is measured. CCR has been proven to be advantageous to both lenders and customers in every market in which it has been adopted. Lenders who fail to embrace the opportunities of CCR may find themselves left with the negatives adverse selection and difficulties in retaining good customers with more options than they have ever had to get the best deal. By being an early adopter a credit provider can enhance their market share as they will be better placed to offer products and services to good customers, with late adopters/followers suffering adverse selection. Risk Mitigation: How will the new data help? It is the application of new data together with your existing internal information and the actions that are taken, not the data that makes the difference which is nothing new. However the availability of new information about how your customers are using credit and with whom, will add value and put your business in a more powerful position to understand a) the total risk of your customer and b) develop the correct action plan to optimise the situation. This process (risk mitigation) is traditionally for the management of high risk customers to reduce the value of realised losses. On first thought it may seem this relates only to collection actions, but that would miss the large opportunities across credit cycle management. On the flip side the same process is one way to optimize profitability for all customers e.g. increasing or decreasing card limits, allowing current accounts to overdraw in addition to the direct collection action. The global economic crisis and associated higher unemployment has resulted in previously good customers struggling to meet their commitments. Forward thinking lenders are aware that prevention is better than cure so have begun incorporating pre collections activity into their credit cycle management, with the aim of reducing the flow of cases into the collection system. Ultimately, it may not be possible to stop an account defaulting, however the earlier that the customer s position is understood, the earlier actions can be taken to manage the risk and lower the loss. In this situation information is indeed power knowing more about the way your customer is using credit, makes it easier to identify those customers that, while not in arrears, are displaying signs of distress. Identification of changing behaviour patterns indicative of financial distress are vital if a lender is to make an early proactive intervention. Additional information available through the introduction of comprehensive credit reporting together with existing internal information held will add significant value to this strategy the availability of ongoing payment patterns with other lenders will be extremely powerful when assessing customer risk. Additionally external bureau data will add to the success of the contact strategy by ensuring that you have the most accurate contact details. Luckily you do not have to wait for another 14 months for CCR some of the lift can be achieved by leveraging Current Credit Provider (CCP) data to better understand the risk profiles of your customers. There is a proven relationship between the number of credit providers and the riskiness of the customer. Internal data alone will not ensure success. Even if you are the customer s primary lender, it is likely your customer will have other data rich accounts, such as credit cards, phone contracts etc with other lenders. It is also likely a customer in the early stages of financial distress will maintain their relationship with the primary lender at the expense of a secondary lender for as long as possible. If the primary lender does not leverage the external data, internal data alone will not highlight the problem and it may be too late when the primary account also starts to deteriorate. 3 Experian Decision Analytics Global Market Update No. 6

5 Current Future Australia Using MOSAIC Full Comprehensive Derogatory Data Credit Active New to Banking Figure 2: Example Experian Credit Bureau based Benchmarking Report The power of combining geo-demographic and bureau data Mosaic is a geo-demographic profiling tool that uses aggregated customer data to provide highly predictive insight into the Australian population. MOSAIC categorises the population into 11 groups that are further split to form a total of 47 types. This tool provides a deeper understanding of any customer base: who, what, where, when, how and why. Understanding a customers demographic and lifestyle when combined with bureau data is a powerful tool to acquire, manage and develop profitable relationships and help achieve business KPI s. The first place where the power of these two elements can be harnessed is for the purpose of building propensity models or strategies. Supplementing customers payment history patterns (bureau data) with their sociodemographic information enables better estimation of their future needs and follow-up behaviour. Further to modelling or building strategies, geo-demographic and bureau data can be used for segmenting pools of customers. Geo-demographic data can slice and dice the population to expose the difference in performance within different segments. Ignoring these differences can create unstable and unreliable forecasts. With the recent changes to the privacy legislation and introduction of comprehensive credit data to Australia, lenders will learn more about their customers payment performance. One vital piece of information that will be missing with the implementation of this change is account balance. In order to make up for the lost predictive power that balance provides, one can either set up and develop a proxy or use additional data sources, such as geo-demographic data, which provides insight into the borrower and their behaviour. The uplift in the performance provided by the geo-demographic data when developing models is demonstrated in Figure 2 (above) for different population segments: Current: Only negative data used. Future Australia: Only data allowed as per the recent changes in the privacy act. Using MOSAIC: Using allowed data as per the recent changes in the privacy act as well as MOSIAC. Full comprehensive: No limitations on the data used. The combination of geo-demographic and comprehensive bureau data enhances the decision making process in multiple areas during challenging market conditions. The insights that it can provide can lead to an increase in customer awareness and support and additionally drive higher sales. Affordability, does CCR give any assistance? With the passing of the privacy legislation, lending institutions will soon have access to a wider range of information about a customer s financial status. When you combine this with the ever increasing stringency around NCCP and responsible lending requirements, it is now more important than ever for lending institutions to be as diligent as possible when assessing an application and ensure any offered credit is affordable. Whilst the exclusion of balance is not ideal, there are many ways, with varying degrees of complexity that comprehensive credit reporting information can be used in the assessment of affordability. If used correctly, these methods can not only help comply with responsible lending requirements, but can potentially enhance the application decisioning process to assist in driving growth, reducing bad debt, decreasing credit losses and minimising operating costs. The following are some commonly used methods to assess affordability and some of the benefits that can come from using these methods: Common methods limit can be used to enhance affordability assessment: Derive affordability using limit: Assume balance = limit. If the customer can afford this, approve the affordability component of the application (conservative) Estimate balance/repayment based on the date the repayment facility started; the credit limit (proxy for initial balance) and a standard repayment curve (low risk) Create an estimated balance model using limit, number of facilities, time since account opened etc (high risk) Calculate affordability using a combination of limit and the customers provided information (e.g. balance) Use geographical estimation models to enhance any limit models Benefits that can arise through accurate income estimation: Direct evidence of responsible lending in line with regulatory guidelines Ensure appropriate and affordable products are offered Improved decision making to: Reduce bad debt Decrease credit losses Target specific sub-populations, e.g. customers with higher capacity Confirm declared liabilities/limits with bureau data, reducing verification requirements Increased ability to segment the data In short, existing affordability assessments may not need to change to accommodate the new CCR information if they are fully compliant with NCCP requirements. However with increasing competition in the lending market and strict government regulations around responsible lending it is inevitable that using this data during will be considered best practice. Given this, the question should not be Will this new information provide assistance when assessing affordability?, instead we should be asking How can we best use this new data to exploit the opportunities and advantages that come with access to new information? 4 Experian Decision Analytics Global Market Update No. 6

6 CCR Questions and Implications Consumer Credit Reporting FAQs Did you know that If you are delinquent in making your payments, it may affect your ability to access new credit? You are entitled to free access to your credit report Credit Reporting Agencies (CRAs) and credit providers need to ensure that your information is accurate, up to date and complete If you dispute an item on your credit report, the CRAs must review and if an amendment is required, notify you and any other delegates immediately Effective March 2014, credit providers will begin reporting and using (under the reciprocity rules) information on all of your outstanding obligations If you are not satisfied with the resolution of a reported problem, you may lodge a complaint with the Privacy Commissioner If you make consistent payments on your outstanding obligations, you may be able to negotiate better loan terms on new obligations These are just some of the implications for consumers of the recently amended Privacy. When a consumer applies for credit, a credit provider is able to obtain information from any of the credit reporting agencies about their credit worthiness. That has not changed. However, the type of information that will now be available to the credit provider has grown multi-fold. Credit providers will be able to obtain access on all reported obligations (under reciprocity principles) for an individual. This includes whether the individual has had any difficulties making repayments to other credit providers. Provisions have been made to limit the type of information that may be held by the credit reporting agencies so, for example, medical records, criminal records, political beliefs and so on are protected. The law also requires that credit providers and credit reporting agencies take reasonable steps to protect an individual s personal information against unauthorised use or disclosure. In consideration of the enormity of the impact to a consumer, it is essential that consumers are educated and informed about the consequences of the new reporting to their ability to access credit going forward. Such education should be government led in order to present the most objective and unbiased view to the consumer. However, the government has made their position clear on this matter. While they acknowledge that consumers do need to be educated, they have refused to commit any funds to do so. In fact, they have placed the financial responsibility squarely on the shoulders of private sector stakeholders. So who will ultimately be responsible for informing and educating the consumer? Like most pieces of legislation, the Act is complex and in order to ensure a thorough understanding by individuals, a systematic and comprehensive education program needs to be put in place to raise awareness of privacy rights and obligations. This is an opportunity for institutions to partner together to inform and educate consumers. For some, this will be an opportunity to build their brand awareness and shape customer behavior. In addition to the Privacy Act, NCCP also imposes a set of responsible lending conduct requirements on credit providers. Compliance with the responsible lending laws will require an assessment and verification of a consumer s credit needs and financial circumstances, including that the consumer has the capacity to repay the new financial obligation. In the US and UK, an individual s financial reputation is represented via their credit score. Most consumers are aware of their credit scores and therefore their ability to access certain types of credit products. Customers with blemishes in their credit history suffer the consequences through higher pricing, i.e. sub-prime loans. Similarly, the new legislation in Australia will enable consumers to take charge of their financial reputation. However, this will require changing the existing mindset. Credit granting institutions need to help train individuals to use credit consciously and responsibly, to make them aware of the consequences of over-indebtedness. Various studies have shown that comprehensive reporting reduces the rates of delinquency and default and results in an improvement in economic growth. Even some of the more vocal opponents of positive reporting now recognise the potential for lending decisions to improve. Ultimately this is a win-win proposition for all! To summarise the implications of positive reporting for consumers: Extension of credit to a wider consumer base in a safe and responsible manner including customers who may have been declined in a negative only environment Consumers incentivised to manage their finances to ensure good repayment history, empowering them to shop around for a good deal Lender s wider view of consumer liabilities reduces the possibility of over-indebtedness, consistent with responsible lending compliance Opportunity for institutions to build brand awareness and shape consumer behavior through targeted education campaign Upcoming Global Events Date: February 15 Event: Experian Insights: RFi Australian Mortgage Conference. Sofitel Sydney Wentworth. Access the latest global knowledge and insights webinars from Experian Decision Analytics: Find global whitepapers, briefing papers and case studies: idecision Analytics Blog : Global Market Update Contributors Jean Abraham Nikolay Dimitrov Michael Sheppard Denise Tipping Paula Bray Nathan Bock Kalpana Rumburg We can help For more information about Experian s Analytics and Consulting services or to learn more about the topics covered in this issue, please contact your Experian Account Director or info@au.experian.com Experian Australia T +61 (03) Level 6, 580 St Kilda Road, F +61 (03) Melbourne, VIC, 3004 info@au.experian.com Disclaimer This material has been prepared by Experian and is general information about Experian s activities. The content is intended for general information and only represents the view and understanding of Experian Asia Pacific Pty Ltd. This information does not constitute legal advice or professional advice of any kind. Before acting on any information you should consider the appropriateness of the information having regard to these matters and you should seek independent advice. 5 Experian Decision Analytics Global Market Update No. 6