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.

Blame FICO for Sub-prime crisis?

Ron Shevlin has a interesting post regarding whom to blame for the sub-prime crisis, and he analyzes if FICO is responsible and to what extent.

I have something to add on the discussion.

I. Blame the Decision not the Algorithm.

Fair Isaac sells algorithm for FICO Score but decisions are taken by the Banks. Normally Credit Scores are tested in the internal portfolio and the operating point is chosen. This process of choosing operating point depends on various business reasons of the operating bank.

i. Case 1 : New Bank and No Internal Data
This is a typical scenario when the FICO score is taken as the only decision platform. Normally any customer having FICO Score above 600 is given a loan or a credit card, with higher the score getting higher loan amount or credit balance.

ii. Case 2 : Stable Bank starting a new Portfolio
Here the Average FICO score on the several bucket of customers on some other existing portfolio is seen and a strategy is formed to fix a certain FICO cut-off for the new portfolio. If there is closely related portfolios then the customized models and the business rules on that portfolio can be used for the new one. Like, many banks use Personal Loan or Credit Card Models and business rules for the other in case of thin file customers.

iii. Case 3 : Bank has mature portfolio
When Bank has mature portfolio, there is little reliance on any Generalized Score, be it FICO, Vantage or any other scores. But still the customers are segmented on the basis of FICO score and then strategy is formed using customized solutions.
The customized solution could be:
1. Predictive Models (Risk, Revenue, Attrition, Response)
2. Business Rules based on Value Segmentation
3. Business Rules by Expert Judgment

II. Portfolio Monitoring is as important as Strategy Forming.

Now let me discuss something on the second part after the strategy formation. It is very critical to monitor the portfolio and fine-tune decision making process. It is solely on Banks discretion and Fair Isaac has no role in it.
This is done by constantly following the market movement and the portfolio shifts. Many a times operational problems within the banks lead to loss of most valued customers while the customers while the low value still remain. This creates the portfolio look bad. This is a common case and is commonly referred to as Adverse Selection. This has to be detected in the real time of Bank functioning and reported to correct the operations.
This step however does not seem to happen as the Banks have come up with bad results. In the presence of good portfolio monitoring system, it could have been reported well ahead in advance and checked.

III. Analyst vs Marketers

Now, this is again a critical thing happening in any bank. All the Business Leaders go to the Marketers to grow the Bank or a particular portfolio. They are given the power to execute their plans and are given a very tight target. Marketers do it and get applause.
Suddenly when the results start getting worse and the bad rate increases, the focus is turned to the Analysts. The analysts have no control on the past decisions but he makes sure that the future decisions is on track. But again by doing this he will be hurting the Marketers interest.

IV. Wrong Bureau Reporting

Many Banks often hide the actual information of the customers to retain their valuable customer base. They report false or rigged information.
Typical scenarios would be
i. to report the failure of payment but hide the clearance done their after.
ii. offer customer add-on cards on the common credit card while reporting multiple card issue in the bureau.
iii. report the data correctly but not on time.
iv. make unnecessary inquiries to the bureau for good customers without him asking for any service to rig the inquiry variables.
v. maintain internal negative list and not inquire the bureau for them for cost savings. The Banks then do not report his application too.

There can be plenty of such examples. Banks are obliged to certain regulations but I doubt either don't follow or find a way to rig the law. Here the Banks forget that if everyone in the market does the same they are ones who suffer.

V. Bureaus, Banks and the Analytics Companies

There are many Analytics Companies playing in Credit Scoring area apart from Fair Isaac and even the Bureaus provide such services. The space is crowded and the competition is getting intense day by day. Result is mixed.

i. Fair Isaac is believed to be squeezing the profit margin for Bureaus with the FICO score Algorithm Licensing. This is creating a scene where Bureaus are not competing against each other to better service but getting together to end the dominance of FICO score once and for all through the launch of Vantage Score. But it has minimal success, mainly because market is heavily dependent on FICO for long and there is inertial friction to change. The other reason being the bureaus not being able to compete with the Technical Depth that Fair Isaac has acquired with around 50 years of Research.

ii. Analytics Companies and Bureaus are coming together to provide solutions to certain interest groups. This is sometimes done through cross investments also, where the deal could be between Bureau, Bank and the Analytics Partner.

My take:

All these were some of the ongoing scenes of the market. Now let me come to the point of whom to blame for the Sub-prime Crisis. I would blame the whole system and the business leaders who tried hard to use Decision Management area as their pet area. They used it in a very unprofessional way and limit it as a tool to serve their interest. I would say, mostly the Analytics Results are used either to support a thought business case or discarded.

Decision Management is a completely different professional service and it has to be given that respect.

Now is the time when the company board or the CEO has to listen to what the Analysts have to say and bring them into the value chain well before crisis comes. If the company has the good Analytics Team in-house, thats great. Else its the time to start outsourcing to the Specialist Companies. The specialist companies are the companies who not only provide Analytics Services like Scores and Segmentation results, but take it forward to decision making and strategy formation space. The safe future thus either lies in Enterprise Decision Management process implementation or outsourcing Analytics Functions completely.

So no blaming FICO at all for the crisis. Bullish CEOs went on aggressive and the Bears had to make their presence felt. Sad news for the world. But certainly, it has strong message for us. Hope everyone learns it right, and overcome without letting it spill over other areas.

Risk Management and Credit Bureau in India

In India, Risk Management is done by Financial Institutions only to small extent and most of the banks are hardly looking at it. They are growing and their focus and priority is set there. But with the Banks facing problems with their forceful collections strategy and higher default rates, they are slowly strengthening the Risk Management process.

India has quite a few Bureaus as of now.
1. Commercial Bureaus
a. CRISIL
b. CARE
c. FITCH INDIA
d. CIBIL
e. ICRA

2. Consumer Bureau
a. ONICRA
b. CIBIL

3. Rural Credit Bureau
a. CIBIL (Dec 2007)

Among all these, the major players are ONICRA and CIBIL. CIBIL which was initially launched by Transunion and HDFC has been the leading player so far and they have currently launched Generic Consumer Credit Score in India.
It is yet to be seen that how far CIBIL goes as Transunion has so far been very unsuccessful in scoring globally. Also a bigger challenge is the entry of Experian to India and Fair Isaac, owner of the most successful Credit Score (FICO Score in US) may not remain far away from Indian story for long. Once these two players come actively into the Bureau and Generic Scoring business, India is expected to see a remarkable change in Risk Management practices.

ONICRA

• Started in 1996 but attained critical mass in 2000
• Largely into Customer/employee verification
• Pan India Presence

CIBIL

• Jointly promoted by the banking community, Dun & Bradstreet and TransUnion International
• Repository of consumer and commercial information
• Provides output in form of Consumer Information Report (CIR)
• BS 7799 (ISO17799) Certified emphasising focus on data security and integrity
• In the process of providing value added products like Credit Decisioning and Fraud Detection Tools

Current Scenario

• Bureaus still acting largely as repositories without much value-add (except CIBIL currently launched Credit Score)
• Banks relying on own resources or third parties for Decisioning and Risk Management, etc.
• Regional and especially Cooperative banks not being aptly serviced
• Member banks still not providing updated information to CIBIL thus reducing its effectiveness

(Originally published in Global Thougtz India)