The Right Bank Collection System Helps When Providing Credit to Underserved Individuals and Businesses
Table of Contents
- Alternative Lending Disrupts the Lending Market
- Fulfilling a Small Dollar Lending Need
- Borrowers Use Payday Loans to Fill a Money Gap
- New Collection Regulation Aims to Protect Borrowers
- Controlling Collection Compliance Still a Priority
- Underserved Small Businesses Encounter Lending Challenges
- Small Business Lending Still a Community Bank Mainstay But Dropping
- Businesses Seek Credit Where They Can Get It
- Small Business Lending and Collections Improves Noninterest Income
- Superior Bank Collections Systems Aids Debt Recovery While Controlling the Risk
With the proper bank collection system in place, helping to monitor risk and debt recovery, financial institutions could extend credit to previously underserved markets such as with low-dollar personal loans, and small businesses.
The issue for many banks and credit unions is how to attract and serve many individuals and businesses lacking traditional creditworthiness.
More flexible underwriting and collection capabilities allow financial institutions to proficiently assess risk and confidently recover debt for all credit and lending programs.
Until recently a bank or credit union required lenders to fit specific, relatively stringent criteria before offering loans to applicants with poor or uncertain credit histories.
Except new competition emerged, in the form of alternative lenders, willing to take a chance on lenders with diverse borrowing requests but without the traditional lending backgrounds and prerequisites.
These alternative lenders range from financial technology startups and publicly traded and private companies, to individuals. What they have is capital to bankroll new opportunities and ventures. What they don't have are the regulatory burdens facing community financial institutions.
Seventy-eight percent of full-time workers live paycheck to paycheck, according to a CareerBuilder report.
However, many households need cash quickly at times. One out of every two American adults do not have enough spare funds to cover an emergency $400 expense, per a Federal Reserve report.
Not capable of retrieving additional cash, millions of Americans seek short-term, small-dollar loans when the need arises. In their desperation for funds, many turn to alternative lenders because they are shut out from traditional sources.
An ABA white paper confirmed there is a tangible necessity for small dollar credit and if traditional financial institutions don’t fill that need lenders will turn to “informal” resources.
Payday loans, frequently perceived as predatory, largely due to elevated interest rates and unregulated collection practices, nevertheless occupy a want for borrowers urgently seeking quick low-value finances.
Community financial institutions usually require lenders to fit certain decision models that consider various factors such as a previous relationship (i.e., a checking account), minimum credit amounts, and the loan applicant’s capacity to recompense the bank or credit union.
Payday loans from nonbanks on the other hand often do not involve a previous customer relationship nor do they limit credit amounts. Many have few terms and conditions and do not even scrutinize an applicant’s ability to repay.
By providing a quick and relatively painless application process, at least upfront, payday lenders took advantage of a market need, which produced almost 16,000 payday lenders, according to the Consumer Financial Protection Bureau.
In 2015, these payday loan companies gathered $3.6 billion in fee revenue, potentially non-interest income for financial institutions, even though they are not authorized debt collection agencies.
This past October, the CFPB stepped in with new regulations aimed at eliminating payday debt traps and providing more stringent repayment guidelines.
For example, the new regulation requires lenders to perform a repayment assessment prior to funding the loan.
When providing some form of short-term credit, lenders can avoid the full-payment test by allowing borrowers to repay the obligation over time.
According to a CFPB fact sheet, the rule diminishes risky loan choices and prevents lenders from forcing borrowers into debt traps or giving up control of financial choices.
Once the new CFPB released its new payday rules, the OCC announced its withdrawal of its small-dollar loans guidance and encouraged financial institutions “to offer responsible products that meet the short-term, small-dollar credit needs of consumers.”
OCC Acting Comptroller Keith Norieka noted the previous guidance injured the consumers it envisioned helping but its continuance would make it even more difficult for financial institutions and subject them to a possibly erratic regulatory course and an additional unwarranted compliance burden.
The new lending landscape created by the CFPB and OCC actions could pave the way for financial institutions to enter the underserved/underbanked market more assuredly.
Collection and lending regulations, even with the OCC rule’s rescission, still requires regulated financial institutions to observe all consumer laws and regulations. Having a robust loan recovery system in place helps banks and credit unions assuages compliance.
Just like consumers, small businesses sometimes encounter challenges when they need access to quick funds.
To seize their stake in this $1.54 trillion market, according to Forbes, traditional banks may possibly need new business lending models, which utilize a more personalized and empathetic approach to smaller commercial customers.
Some experts point to a cause and effect reaction to the Great Recession during the late 2000s for curbing community banks and credit unions appetite for providing loans to small businesses. This hesitancy by community financial institutions-provided a window of opportunity for two ends of the lending spectrum: bigger banks and alternative lenders.
Small business lending is still an essential community bank service — with all banks under $10 billion offering loans to small commercial entities, according to the ABA. These financial institutions represent 54% of small business lending.
Nevertheless, community financial institutions are losing ground, revealed a survey released in October 2017 by the Federal Reserve and the Conference of State Bank Supervisors. That report discovered small business lending at community banks fell by 2.2% to $269 billion in 2016; and banks over $10 billion moved ahead of community banks in overall origination volume, increasing by 5.1% from 2015 to 2016, to $284 billion.
Within community bank portfolios, small business loans likewise degenerated, falling slightly from 16.6% to 15.9%, according to the October Fed report.
Cash-flow issues cause 75% of small business to put off normal purchases annually or semiannually, according to a Mercator Advisory Group study.
When they need funds small businesses often come across rigid lending policies at traditional financial institutions. Subsequently, they turn to any available sources ranging from maxing out their cards and lines of credit to alternative lenders.
One alternative lender making a big splash lately is Amazon Lending, which offers short-term business loans ranging from $1,000 to $750,000 for up to a year. Amazon provided $1-billion in to more than 20,000 to different types of small businesses in the United States, Japan and the U.K. from June 2016-June 2017.
An added incentive for community banks and credit unions is small business loans boost the use of other financial products.
Almost 95% of community financial institutions signed up small business borrowers for deposit services, while 38% delivered cash management services, according to the ABA Banking Journal.
That is why financial institution should find encouragement in the latest Biz2Credit Small Business Lending Index, which disclosed commercial loan approval rates at banks ascending going into 4Q2017.
Vigorous collection software presents banks and credit unions with extensive loan collection data reporting. This better quantifies their risk tolerance while enhancing loan efficacy and the capacity to compete for small dollar or small business loans without compromising credit quality and debt recovery.
Dynamic reporting also supports management of the loan risk while allowing financial institutions to preserve some judicious underwriting and risk management standards.
Financial institutions utilizing exceptional debt recovery capabilities can pull detailed (collection specific, not origination decisioning) scores during the loan’s entire cycle, and allocate the best channel appropriate bank collection workflows to produce greater results.
Established best-of-breed collections systems assures the completion and documentation of vital steps, while improving compliance and holding collection costs. Providing a 360-degree borrower assessment, of every account, delivers key information to subsequent collection decisioning.
An adaptable system also allows financial institutions to efficiently control the risks associated with the products and services they offer, whether it is related to credit, operations, compliance, or reputation.