World Needs Payday Lending

Payday Lending is one of the most discussed topic in Finance Industry for many months, and most of the thoughts have come against it. Being a Analyst with Interest in Subprime Lending and smaller Loans, I was looking at these market developments.

Here are few of my observations:

1. Lender's Greed went uncontrolled

There are various players in the US Market who are actively into Payday Lending. There were people who entered the market with long term Marketing Strategy while others went to make quick money. These later class had too much of greed, and were charging around 720% to 800% APR, annualized percentage interest rate (30% for 15 day cycle + administrative fees). This is certanly too bad to do any good to the market.

2. Market moved from Bad to worse

The very high interest rates forced more people to become bad, and default on their loans. This piled off huge debts on the individuals who used payday loan. This again made them not laible to Payday Loan too, and moved them from Underbanked to Unbanked Mass.

3. Early Movers Made Money, Late Movers Died

Early movers made huge amount of Money. They capitalized on the urgent need of cash for utility bill payment and others for underbanked population, and build a good customer base. As the market was raw, they got chance to exploit its full potential. 

The advantage of the early movers were the lack of intentional fraudsters in the market, and the monopoly to choose best leads. As the competition increased, the market was exposed to many fraud cases along with high risk of giving loan to less credit worthy leads. This was coupled with more people being moved from good to bad with the imposition of very high interest rates.

4. Use of Data Made Kings, others make their way out

There are certain companies which went out of the market citing great loss, and others like are still the kings. They have huge portfolio of around $50m in a market where the profitability of close to 10-20% Monthly. All thanks to proper database maintence and use of Risk Management Practice.

They not only used their data to lower risk, but also used to retain the good customers.

5. Payday Lending is a Risky Game, High Interest Rates are inevitible

The market of udnerbanked and unbanked where Payday Lenders actually target is a very risky population. It has very low credit worthiness, and the credit rating cannot be done due to thin file accounts. This make the Risk Management Task very challenging.

More pain is added by the lack of information to have good Fraud Model too. The portfolios of various clients, which I have seen so far have an average bad rate of 15% to 40%. This is after the Risk Control measure. When I made an analysis to predict the Bad Rate of random population, it came around 85%. 

So if you look at these statistics, you will know how important it is to charge high Interest Rates. I feel Interest Rate of around 120% APR (5% for 15 days) is reasonable, and it can go upto 240% APR.

6. Payday Lending is necessary, World got it wrong

Payday Lending is blamed for distubing the market by many activists and serious bankers. They do have some point, but all they say does not hold true.

When I miss a credit card payment, bankers charge me huge amount. Once I missed a payment of Rs. 800 and the bank charged me Rs. 1400!! It includes interest rate and late fee. Had I taken loan for Rs. 1000 and paid it, it would have saved Rs. 1,100 after paying the interest rate of 30% for 15 days.

So a serious question to be answered, is Payday Lending a real monster? Or is it a blessing in disguise? I would not be surprised if someone prove the hand of big Banks in the movement against the payday loans. Afterall they lose huge money in administrative fees if people pay the EMIs and Credit Card Installments on time.

It is also coupled with teh loss of govt. agencies and other companies. People have option of taking a payday loan immediately and pay the utility bills on time to avoid the administrative fees.

My Take:

Payday Lending Loans can be taken under Smaller Loans Act, and the interest rates needs to be capped. But the cap rate should be 240% and not 36%! No Payday Lender can live at 36%, and authorities need to undnerstand this ground reality.

General public will lose an option to not pay the hidden fees of big banks, if payday lending is abolished. This is not in bigger interest of the nation.

Instead Market needs to be left free hand (ofcourse with CAP) to function, and the competition will bring the interest rate down. Good Attritors will be retained and this retention is not possible without lowering the interest rates. The new and the risky might have to pay high rates, but thats fine as they will get cheaper loans with time.

Analytics for Payday Lenders

Loan Amount Sensitivity Analysis and Interest Rate Sensitivity Analysis

(If there is availability of relevant data)

a. See the effect of one factor at a time to each relevance factors (removing effect of other factors).

b. Form a strategy by combining all factors

c. Aim will be to increase the portfolio amount and thus increase revenue, keeping acquisition cost and risk low.

Bureau Data Use Optimization

In the current scenario very high acquisition cost is expected as they inquire many sources.

Business Rules

• Based on segmentation
• Based on Business Intuition

Predictive Models

FPD Model, Revenue Model, Conversion Model, Attrition Model, and Risk Model (like by behavior up to cycle 6)

a. Leads approved but not converted will affect the performance as it is resource intensive (like have to call to verify, do verid checks etc).

b. Leads which generate income less than Acquisition plus Operations cost are actually the loss making leads (hence can be called Attritors).

c. Good Profit comes from people

i. who actually go bad in the first pay but pay later with the late fee

ii. who renews cycle over cycle and stays long

d. Risk based pricing to decrease withdrawals

i. Lower interest rate for reactivations.

ii. Higher loan amount and low income for reactivations.

iii. Low interest rate for high score candidates (who score high in all scores – Revenue, FPD and 6 Cycle Risk).

Multiple Objective Decision System

a. Strategy Table and Joint Odds Approach

i. This technique is used if the number of dimensions is less. Up to four relevant factors (like Generic Score, Revenue Score, FPD Score, and Conversion Score) can be combined using this approach.

ii. Tackling more than four factors becomes extremely difficult.

b. Joint Score Approach

i. All Risk Related Scores are combined to form a single score (Joint Score).

ii. This approach can handle any number of scores.

iii. All decisions are based on this one score only

iv. There are ways to give more weight to one Relevance Factor over other (like giving more weight to Revenue than FPD).

Other General Analysis

a. Fraud Check (few examples below)

i. People who write name in improper capitalization are more likely to be fraud.

ii. When Home Phone and Work Phone is the same.

b. Miscellaneous Analysis (examples below)

i. Behavior in Military Population

ii. Absolute Income Behavior

iii. Loan to Income Ratio Sensitivity Analysis

iv. Lead Aggregator Performance Analysis

v. Lead Position Performance Analysis