Loan volume growth is a top priority for community financial institutions. Money availability pressure on bankers has prompted a number of steps to make give borrowers more access to cash.
Lender professionals have lowered interest rates. Credit standards have been relaxed to induce borrowing. Amount of application fees have been waived.
This situation of fast approval and wider access to funds puts a heavier burden on collection systems. Modern collection systems must proactively manage any elevated risk and help ensure profitability.
Loans are creating fierce competition among banks, credit unions, payday lenders, and non-bank lenders. Debt payment accounts are sought by people with various credit score levels. Any person can get a loan amount decision, rate, and term on business loans, home mortgage loans, real estate and auto loans, and lines of credit. All in a challenging economic environment with less stringent underwriting standards that can lead to faster default.
Lender compliance with bank service regulations is an additional process that can increase expenses and further weaken financial institutions already facing diminishing profit margins. For example, one form of regulation is the Dodd-Frank financial reform law.
Loan revenue improvement is one way to increase bank income. More options include increasing lender margins and boosting debt collection strategies.
How Financial Institutions Compete for Loans
Banks should seek ways to serve bank account holders’ needs and build relationships with credit worthy customers. Some financial institutions use rates and fee to compete with each other and nonbank competitors via easy-credit schemes. Some industry experts believe this leaves banks and credit unions more vulnerable to client-poaching from competitors with more tempting offers.
The amount of small business loan volume at community banks is more than 50%, and almost half of commercial real estate lending, according to a Harvard Business School white paper. A lot of home town economies depend on the underwriting capabilities of local financial institutions engaged in strong, appropriately underwritten loans.
Borrower Payment Needs and Account Service Types
- Cash needs (ongoing): Capital lines of credit
- Credit needs (ongoing): Credit cards or unsecured revolving credit
- 1 to 3 year payments: Short-term commercial loans
- Longer term payments: Commercial loans (typically secured by real estate or other major assets)
- Business equipment needs (option to not purchase outright): Equipment leasing services
- Facilitate buyer and seller transactions: Letters of credit
Money lending by banks and credit unions is also typically for home repairs and significant necessities such as vehicles and education.
Traditionally bankers would ask questions that targeted people who met pre-defined measures before offering these types of loans. This process deterred applications from people with a poor credit history.
However, in the post 2009 banking crisis atmosphere, banks and non-banks sought more aggressively to satisfy growing consumer demand for credit. A similar policy helped grow mortgages, home equity loan products and home equity line-of-credit balances.
Alternative Lenders Challenge Bank and Credit Union Loan Growth
The burgeoning online lending market fueled the alternative environment with appealing technology platforms; the ability to use alternate data sources to judge creditworthiness; and rapid growth of new companies and product offerings geared to borrowers.
By using technology and unconventional underwriting techniques, many alternative lenders vied for borrowers with quicker processing times, automated apps, minimal demands for financial documentation and same-day funding, services most community banks struggled to match.
Harvard Business School called this phase the “wild west,” fueling fear that disruptors would capture a large share and dominate the lending market because for many consumers it does not matter whether a loan comes via a bank or a non-bank.
According to a Washington Post article, in 2011, 50% of all new mortgage money originated from the three biggest banks in the United States: JPMorgan Chase, Bank of America and Wells Fargo. But by September 2016, the share of loans by these three big banks dropped to 21%.
At the same time, in 2016, six of the top 10 largest lenders by volume were non-banks, such as Quicken Loans, loanDepot and PHH Mortgage, compared with just two of the top 10 in 2011.
Rising aggressive competition from unregulated lender sources performing a number of bad practices, such as lending to dubious borrowers, prompted calls for regulatory action as community banks sought ways to compete. Meanwhile, banks began to drop approval standards on current loan products, and offering new or expanded loan product offerings in an effort to attract new borrowers.
Even when banks withdrew, borrowers found payback loans and ready financing from alternative lenders such as Kabbage, Accion, RapidAdvance, OnDeck, Crest Capital, Merchant Advisors, PayPal, RapidAdvance, SnapCap and Square.
Some research also suggests these nonbank lenders may offer growth opportunities for community financial institution in terms of formal partnerships and alliances.
How Risky Credit Decision Making Triggers Bank Regulator Attention
When relaxed loan underwriting decision standards appeared amid fierce competition, particularly for vehicles, some regulatory bodies took notice. The practice triggered concerns that financial institutions are taking on too much risk and skirting around compliance standards.
According to data released by the Federal Reserve Bank of New York, outstanding household debt increased by 1.2% in the first quarter of 2017, bringing household debt above its 2008 peak and driving increases in almost every debt category.
In particular, auto loans have grown rapidly thanks to numerous Americans who went on a motor vehicle shopping spree in recent years. Many paid for their vehicles by taking out a loan. That explains why a record 107 million Americans, about 43% of the entire adult population in the U.S., have auto loan debt.
In early 2012, only 80 million Americans had car loans. In fact, more Americans had home mortgage loans than auto loans in 2012. Today, home loans are far outpaced by auto loans.
The concern is that six million people are 90 days or more behind on their car payments, according to the Fed data.
The Office of the Comptroller of the Currency warned that the $1 trillion car loan industry has gotten more dangerous due to its unprecedented growth in auto loans, rising delinquencies, dwindling used car values, and relaxed underwriting standards.
The OCC report, for example, also raised concerns about auto loans, especially the lower-quality agreements known as subprime. Some industry onlookers even admitted that auto lending looked stretched. Banks giving dealers cash to lend to car buyers, a practice called indirect auto lending, is also an area to watch for “significant fair lending risk,” the OCC said.
Several regulatory bodies currently engage in some aspect of the online lending market for small business loans. However, non-bank business lenders are not currently regulated with explicit authority by any federal regulatory body.
Following the 2009 mortgage lending crisis, the cost of complying with new regulations and the risk of making mistakes forced numerous financial institutions to pay fines, retract flawed loans and reduce their mortgage business.
Simultaneous additional requirements include meeting stress tests and more capital on hand to handle the defaults. These requirements burden banks, while non-banks that don’t need capital
According to the OCC, credit risk continues to require the most attention by federal banking regulators. The OCC noted particular concern about commercial real estate concentration risk at community banks. The regulators issued a joint statement in December 2015 to reinforce the importance of prudent risk management practices for CRE lending.
How to Reduce Credit Risks at Financial Institutions
Several credit risk trends in particular warrant attention from financial institutions including sales practices, portfolio composition and credit philosophy.
Sales Practices – Following the Wells Fargo scandal over bogus accounts, the OCC added a strong emphasis on governance of sales practices. “Control breakdowns over the governance of retail product sales practices can erode trust in the banking system,” the agency said. “Effective systems to detect and address fraud and possible unfair or deceptive practices in a timely manner, including effective complaint management systems, are critical.”
Portfolio Composition – Community bank and credit union loan portfolios face several risk issues. In an effort to drive revenue and locate new revenue sources, some have started to offer riskier products such as subprime, student and mezzanine loans, a hybrid of debt and equity financing.
Credit Philosophy – Surrendering to the increasing state of more loan volume pressure, more community institutions offered new products and eased underwriting to drive up their loan volume. Risky option layering, such as additional policy exceptions, higher loan-to-value ratios and flimsier covenants, amplifies the continuing trend to facilitate underwriting.
Mounting credit risk, coupled with a low interest rate environment; increased cost of regulatory obedience; and general uncertainties and compliance requirements, created apprehensive bankers. Especially since state and federal guidelines govern repayment conditions regardless of loan type to protect consumers from unsavory practices.
Powerful collection software helps increase income while keeping outstanding loan repayment delinquencies down, preventing some charge-offs, and facilitating recoveries of prior charged-offs.
A robust collection system uses fully automated debtor messaging whenever possible such as voice messaging, email, text, voice to voice, and letters to encourage repayment on time. Its account relationship profile also provides a complete 360-degree debtor view.
This provides banks and credit unions with the best techniques to help leverage specific scores (contact-ability, collectability, overall recovery) during the loan servicing life (versus loan origination scores), and best channel appropriate collection work flows that yield the best possible results to the financial institution.
Another important byproduct is strong compliant collection-documentation with automated portfolio performance tracking and reporting.
In order to remain successful and grow lending revenue, financial institutions must ensure they retain all of their current customers’ needs while adding new accounts that endure.
Banks and credit unions with solid loan collection data reporting can better measure their risk tolerance while increasing loan effectiveness without compromising credit quality or going beyond their risk appetite.
Hold debtors accountable to payment commitments with swift, often automated, reaction to failed payment promises, and reward debtors who honor payment promises with an automated thank you. This maintains order and ensures greater profitability even in a riskier loan environment.